Delta hedging

Delta hedging – refers to adding long delta or short delta to an existing position, usually to reduce risk on a option spread that is going against you faster than you would like.

Typically if your long delta position is working against you, you are delta hedging with short delta, and vice versa.

For example, a common problem with iron condor option spreads is that if there short strikes are hit, you have a very directional trade from a trade which originally had a neutral assumption. Let’s assume your iron condor started off life having a -$5 delta (pretty neutral to very slightly bearish), and overtime the short call is hit and you now have a position with +$50 delta. However you would like to remain neutral. You can delta hedge this position by adding short delta, for example adding an OTM short put spread might give you -$35 short delta. This would bring your overall position delta to long delta +$15 ( +$50 – $35 ). Delta hedging is therefore usually any position adjustment that reduces your delta (long or short) in the direction that is hurting you.

Delta neutral trading is a extreme version of delta hedging, where you always try and keep the overall position as close to neutral (zero delta) as possible. This is take advantage of market conditions like option time decay or volatility mean reversion, without caring so much about underlying price direction.

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