Delta rebalancing is a risk management strategy in options trading that involves adjusting the underlying asset holdings of a portfolio to maintain a neutral or desired delta exposure. Delta, a Greek value, quantifies the sensitivity of an option’s price to changes in the price of its underlying asset. This technique aims to minimize directional market risk for an options position or an entire portfolio.
Mechanism
The operational process entails continuously monitoring the delta of an options position or a portfolio, then executing trades in the underlying asset (buying or selling) to counteract changes in delta caused by price movements, time decay, or volatility shifts. This dynamic adjustment often relies on algorithmic execution, which automatically places orders to restore the target delta. The frequency of rebalancing depends on market volatility and the desired precision of delta neutrality.
Methodology
The strategic rationale behind delta rebalancing is to hedge against price fluctuations in the underlying asset, effectively isolating other risk factors like volatility (vega) or time decay (theta). This methodology requires accurate pricing models for options and efficient execution capabilities in the underlying market. It is a critical component of market-making strategies and complex derivatives hedging, seeking to maintain a predictable risk profile amidst dynamic market conditions.
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