Delta-Gamma Hedging
Categories: Derivatives, Trading, Investing
Sounds like a wild frat ritual, but far from it. In fact, it has to do with playing it safe in the realm of options trading.
First things first: In options trading, delta refers to the ratio that compares the change in the price of the underlying security to the change in the price of its corresponding derivative. So if an option has a delta of 0.40, when the underlying stock price increases by $1 per share, the value of the option will increase by 40 cents a share.
Now for gamma. Gamma is the rate of change of the delta itself. So if a long call option has a gamma of 0.10 and a delta of 0.40 and the underlying stock increases by $1 per share, the delta will now be 0.50.
With delta hedging, a trader protects herself from small price movements in the underlying stock by offsetting with either a long or a short position. But a large price change will also cause a big change to the delta. So by adding a gamma hedging strategy, the trader can effectively prevent the delta from moving.
Yep. It's all Greek to everyone but options traders.
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finance a la shmoop what is a derivative? well it's derived it's a something taken
from something else like a derivative of hot weather is thirst a derivative of [Girl takes sip of glass of water on a beach]
hunger is well you know crankiness that's diva thing you get there...
derivative of a 1/32 quarterback rating in the NFL is like serious wealth yeah
yeah discount double shmoop yeah look for it be on there with aaron
and a derivative of a stock or bond or other security is a something which
derives its value based on the performance of that underlying security
there are basically two flavors of derivative put options ie the right to [Ice cream flavors appear]
sell a security at a given price over a given time period and a call option, ie
right to buy a security at a given price over a given time period
well the price of that option is derived from the price of the security and a few
other factors like strike prices and duration and all that stuff
colonel electric the downgraded new version of General Electric is trading [Colonel Electric appears in a suit]
for 25 bucks a share a derivative of its share price is sold in the form of a
call option with a $30 strike price expiring about 90 days from now on the
third Friday of the end of that month well investors pay a price albeit
probably a small one for the right to then pay 30 bucks a share for colonel [Call option appears for colonel electric]
electric at any time in the next 90 ish days until that option expires making the bet
that the stock will go well above 30 bucks a share in that time period that
call option is thus a derivative of the colonel electric primary stock price got
it if you really want to get personal well here's the ultimate form of
derivative [Baby laying down]