Delta Hedging: Using one operation to reduce option risk to 0

To be honest, what is the most feared thing in options trading? When price fluctuations occur, your position may crash. But professional traders have a special trick called Delta Hedging—in simple terms, it's about using reverse operations to offset risks and lock in uncertainties.

What the hell is Delta?

Delta is a measure of how quickly an option follows the price movement of the underlying asset. The range is -1 to 1:

• Delta=0.5: If the asset increases by 1 unit, the options increase by 0.5 units.
• Delta=0.7: This option has a 70% probability of being profitable at expiration.
• The Delta of a call option is positive, while that of a put option is negative.

The key is that Delta is not fixed. When the asset price moves, Delta changes as well (this is called the Gamma effect), so hedging needs to be continuously adjusted.

How to do Hedging?

Call Options Hedging: If you hold a call option with Delta=0.6 (100 contracts), selling 60 shares of the underlying asset can offset price risk. Once the asset rises, the money earned from the option is offset by the loss from the stock, and vice versa—perfect balance.

Put Options Hedging: Conversely, buy stocks instead of selling. A put option with Delta=-0.4 requires buying 40 shares to hedge.

The difficulty of hedging options varies in different states:

• In-the-money options (have intrinsic value): Delta is close to ±1, hedging requires buying and selling more underlying assets.
• At-the-money Options (close to strike price): Delta approximately ±0.5, moderate Hedging volume
• Out-of-the-money Options (no intrinsic value): Delta is close to 0, less hedging demand.

Advantages vs Disadvantages

Advantages:

• Stable investment portfolio, not afraid of small fluctuations
• Adjust at any time, adapt to any market
• Lock in profits while maintaining flexibility

Disadvantages:

• Need to monitor the market daily and frequently adjust positions (time cost skyrockets)
• Trading fees eat into a lot of profits
• Can only hedge against price risk, powerless against fluctuation and time decay.
• Requires large capital support, retail investors cannot afford to play.

Who is using it?

Mainly market makers and institutional investors. They manage large positions and need to use Delta Hedging to control directional risk, while profiting from time decay and fluctuation changes.

Bottom line: Delta hedging is a double-edged sword. When used correctly, it can significantly reduce risk, but it is costly, complex to operate, and requires specialized knowledge. Not everyone can afford to play with it, but for large capital players, it is an essential tool.