Delta dynamic hedging
1 Introduction
There are four basic trading styles in options trading: buying a call option, selling a call option, buying a put option, and selling a put option. Through the combination of four basic trading methods and options with different exercise prices, various vertical spread combinations, straddle combinations, wide straddle combinations, etc. can be derived. No matter how complex the configuration of an option portfolio is, its most basic attributes are still determined by multiple Greek letters such as Delta, Gamma, Theta, Vega, and Rho.
Delta value measures the change in option price caused by changes in the price of the underlying asset when other parameters remain unchanged. From a mathematical perspective, delta represents the first derivative of the option's fair price with respect to the underlying asset price. Delta is a function of S, and it is also a function of the exercise price and expiration time. Since Delta describes the sensitivity of derivative prices to the price of the underlying asset, such a portfolio can be effectively hedged, and a delta-neutral portfolio can be formed through hedging.
In the financial field, if a portfolio consists of related financial products and its value is not affected by small price changes in the underlying assets, such a portfolio has delta-neutral properties. The components of this kind of portfolio usually include options and corresponding underlying assets, so that the positive and negative deltas cancel out, making the price of the portfolio relatively insensitive to the price of the underlying asset.
Delta hedging is a concept related to delta neutrality. This type of hedging describes the process of keeping a portfolio's delta as equal to or as close to zero as possible. Maintaining zero delta is difficult in practice. This is due to the higher risk of hedging again when the price of the underlying asset changes significantly. Additionally, research shows that frequent hedging can lead to low cash flow in a portfolio.
2.Delta neutral and hedging strategies
Delta hedging: After avoiding the impact of the underlying price (Delta) on the investment portfolio through dynamic hedging, the focus of the trading strategy can be shifted to volatility and time dimensions (Gamma, Theta and Vega)