"Delta Hedging" -- everything you ever wanted to know & more.
Max-Master-Mish keeps using the term "delta hedging" when discussing Max Pain. I was wondering what it meant, so I looked it up.
For those who are interested, here it is in all its glory:
Delta Hedging: Strategy which consists in establishing an options position whose value varies in accordance with changes in the price of the underlying so that a profit or loss on the underlying position is offset by a loss or profit on the option position. finance.wat.ch
Delta hedging
A strategy used by option sellers to protect their exposure, ie, to be 'delta-neutral'. delta hedging involves taking steps to offset price/rate risk by matching the market response of the underlying asset over a narrow range of price/rate movements. (option buyers do not need to worry about delta hedging because their potential loss is limited to the outlay of an initial premium.) To structure a delta hedge, an option seller takes into account changes in the spot price, the time to expiry and the difference between the strike and spot prices. The more an option is in-the-money the greater is the amount of delta hedging. A deep in-the-money option has a delta of close to 1, or even 1, because it is likely to be exercised; a deep out-of-the money option would be close to or at zero because the option has very little intrinsic value. anz.com
A Simple Example of Delta Hedging library.wolfram.com
Tutorial: Delta Hedging in the Binomial Model ftsweb.com
Here's more fun stuff about why delta hedging is so important:
Delta-hedging strategies play central role in the theory of derivatives and in our understanding of dynamic notions of spanning and market completeness. In particular, delta-hedging strategies are recipes for replicating the payoff of a complex security by sophisticated dynamic trading of simpler securities. When markets are dynamically complete and continuous trading is feasible, it is possible to replicate certain derivative securities perfectly. However, when markets are not complete or when continuous trading is not feasible, e.g., trading frictions or periodic market closings, perfect replication is not possible. lfe.mit.edu
Finally, if you have a hankering to do some delta hedging at home, here is a website where you can purchase an "Easy Excel program for delta-hedging with call options!" (only 5 Euros!) tradersdownload.com |
