Traders who want to be more professional and make winning moves may need complex strategies such as delta hedging.
Why You Need to Learn About the Delta Hedging Strategy
Once you have enhanced your experience of stock trading with direct access trading platforms, you may want to look for more advanced trading strategies to better manage risks and maximize earning opportunities. One of these advanced strategies is delta hedging. It may be complicated to get it right, but if you’re looking for advanced strategies, you need to consider this.
What Is Delta Hedging?
Delta hedging is a strategy in trading by which you arrange an option play. Which helps in decreasing or eliminating the potential directional risk exposure of an underlying stock, or any option contract you hold.
Stocks and options generally have directional exposure to price moves. This exposure, called delta, is measured by how much a trading position earns or loses when the stock undergoes a $1 move. For example, if a call option makes a 50-cent movement for every $1 move of the underlying stock, it has a .50 delta.
Options are used to balance the risk to another option holding or a whole portfolio. The investor aims to attain a state of delta neutrality without any directional bias. A long position without a hedge has a 1.00 delta while a short position without a hedge has a -1.00 delta.
Pros as Well as Cons in Delta Hedging
For traders, delta hedging can help isolate any changes in volatility. But a major drawback is that you would need to keep watching the positions involved and adjust them. And since delta hedges get added and removed with the underlying changes in price, the trader incurs further trading costs.
Delta hedging is complicated, and it’s usually carried out by investment banks and institutional traders. But even individual traders can carry out a simple version of it. This involves buying or selling options before buying; or selling stock or ETF of an equivalent amount.
But whatever delta hedging practice are used, the hedge needs to be constantly rebalanced since you are looking to neutralize the price of an option in relation to the price of an asset.
A Complex Delta Hedging Strategy
A more complex strategy involves trading volatility with a delta neutral trading strategy. Delta neutrality refers to a portfolio strategy where multiple positions are utilized along with positive and negative deltas to ensure that the overall delta of the concerned assets are zero.
NewTraderU describes positive and negative delta positions. The positive delta positions are long stock shares, long call options, short put options, buying call spreads and selling put spreads. The negative delta positions are selling stock short shares, long put options, short call options, selling call spreads and buying put spreads.
Why You May Need Delta Hedging
Due to the complexity of the process, Delta hedging is expensive. But, it can be of great benefit for traders anticipating a strong move in the stock they hold, but are worried about the risk of over hedging; if the expected move doesn’t quite turn out that way.