Delta Hedging is a dynamic risk management strategy employed in options trading to reduce or completely neutralize the directional price risk, known as delta, of an options position or an entire portfolio by taking an offsetting position in the underlying asset.
Mechanism
This process involves continuously calculating the delta of an options position, which measures its sensitivity to price changes in the underlying cryptocurrency. When the delta deviates from a desired target, typically zero for a perfectly hedged position, the system dynamically adjusts the quantity of the underlying asset held, buying or selling it to rebalance the overall exposure and maintain the target delta.
Methodology
The strategic objective of delta hedging is to isolate and manage other option Greeks, such as gamma and theta, allowing traders to profit from factors like volatility changes or time decay while minimizing exposure to the underlying asset’s price fluctuations. This methodology is fundamental for market makers and sophisticated institutional traders who aim to maintain a risk-neutral or precisely targeted risk portfolio.
Hedging RFQ inventory with futures prioritizes capital efficiency at the cost of basis risk, while a spot hedge offers risk finality at the cost of higher capital deployment.
Markout analysis diverges from a linear price-impact measure in equities to a multi-dimensional risk attribution model in options, isolating execution cost from market-driven P&L.
Implied volatility governs large options RFQ pricing by defining the cost of risk transfer, directly influencing the quote and the subsequent cost and complexity of the dealer's hedging strategy.
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