Delta hedge
To hedge an option exposure, combine it with an opposite-signed exposure to the underlying or suitable instruments. Multiply option delta by the number of underlying units represented, taking long and short signs into account. Delta neutrality is local and temporary: gamma, time decay and changing volatility can alter the exposure. Rebalancing has transaction and funding costs, and does not eliminate all option risks. The hedge objective and limits should be clear, especially where the underlying is not traded or cannot be held in the required quantity.
Worked example
A dealer is short 100 call contracts, each representing 10 shares, with call delta 0.6. Option-position delta is −100×10×0.6 = −600 shares. Buying 600 shares creates an approximately delta-neutral position at that moment, before other risks and costs.
Common mistake
Hedging 100 contracts as though they represented only 100 shares, or describing delta neutrality as protection against every market change.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Direct | September 2026–June 2027 |