Question

Describe how delta hedging works. Short answer please. You have only six lines:

1- why do traders do it,

2- what is it that they are basically betting on (spot, forward points, volatility, the passage of time)?

3- what exactly do they do?

Answer 1

1. In delta hedging, traders hedge their position in the option with shares in the underlying assets. Trader who is long on call option will hedge his risk of declining underlying asset price below strike price by short selling the shares of underlying assets. While trader of put option will hedge his position by buying the shares of underlying assets.

2. Traders basically want to hedge against forward price of underlying asset.

3. Suppose trader buy call option or sell put option. It means if traders is long on the stock then he should hedge his position by short selling the stock as he want to reduce the risk against future decline in stock price. Traders will do it by calculating the delta for the option position. Delta is ratio of change in option price to change in stock price. It measures the number stocks (buy/sell) require to hedge the option position. Delta for call option is between 0 to 1 and for put option between -1 to 0. For trader has long call / sell put position then he will sell the underlying stocks by multiplying delta with the current stock price and if trader has short call / long put position the he will buy underlying stocks by multiplying delta with the current stock price