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.
Binary options offer a fixed-payout hedge against discrete events, while traditional options provide a dynamic, proportional hedge against continuous market fluctuations.
Hedging binary options is a challenge of managing discontinuous, explosive risk at a single point, unlike the continuous, manageable risk of traditional options.
The binary option's fixed payout transforms risk management from a probabilistic exercise into a deterministic discipline of managing event boundaries.
A simple delta hedge fails for binary options near expiry because their Gamma approaches infinity, making the required hedging adjustments impossibly large and frequent.
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