Delta Hedging
Candlefocus EditorThe easiest way to delta hedge is with options. By buying/selling a certain number of contracts of the same underlying security but varying its expiration dates, an investor can create a delta-neutral position. For example, an investor can buy a long call option with a certain expiration date and then write a covered call option with the same strike price but for a later expiration date.
When delta-hedging, it is important to remember that the underlying security’s price movements can still impact the position, creating a situation where hedging is needed even if the delta stays at zero. A delta hedge will not take into account non-price factors such as dividends, earnings news, mergers and acquisitions, etc. However, delta hedging can still be a worthwhile endeavor, as it allows an investor to isolate volatility changes and limit their downside risk.
The main downside of delta-hedging is the time and cost investments necessary to successfully use the strategy. Without ongoing monitoring, delta-hedging may become futile due to changing market conditions. When such conditions arrive, delta-hedgers may be required to adjust their positions at their own expense. Additionally, when trading options, constant Delta-hedging may end up costing the trader a significant amount in fees and commissions.
In conclusion, Delta-hedging can be an effective technique for reducing directional risk and isolating volatility changes, however, traders should be aware of the associated costs and possible losses if the strategy is not properly executed.