tastytrade logo
uploaded image

May 2, 2016

Eliminating Direction | Delta as a Hedging Tool

By:Josh Fabian

You’ve probably heard us talk about our total deltas on tastytrade. If not, turn up the volume. When we talk about delta, we are essentially discussing directional risk. As deltas grow larger, directional risk increases. To neutralize that risk in our option positions, we can use shares of stock to hedge our deltas.

Using Options as a Share Equivalency to Stock

Delta is a measure of share equivalency. One share of stock has a delta of one. Long 100 shares equals 100 deltas. Short 100 shares equals -100 deltas. An option with a delta of 1 (-1) is equivalent to 100 (-100) shares of stock (remember: each option contract leverages 100 shares).

Delta’s Relationship to Price

A position of 100 shares in a stock will fluctuate by $100 for every $1 that stock moves. Delta conveys how much an option’s price will fluctuate for each $1 change in stock price. An option with a .50 delta will move half as much as changes in a stock’s price. For example, an option trading for $1 with a .50 delta will move $0.50 for each $1 the stock moves.  

Hedging Ratio

To hedge options against changes in price, we simply need to buy (sell) shares equal to position delta. For example, if we are short a call option giving us a delta of -25, we can buy 25 shares of stock to offset risk (assuming volatility, time and gamma remain constant). If we are short a put with a delta of 1, we can sell short 100 shares of stock to neutralize our position.

Option delta is not static. When the price of an underlying changes, so too does the delta of an option. Depending on the level of risk desired, we may adjust our deltas. It is common to see what began as a delta neutral position take on directional exposure as a stock’s price changes. That’s okay. We are not delta neutral traders. In fact, we almost always have some directional risk. Where tastytrade differentiates itself is in our use of delta to keep risk at an acceptable level.

Delta hedging is one of the most important trading concepts. It quickly lets us know our directional exposure. Using various hedging techniques allows us to control how exposed we are.

Josh Fabian has been trading futures and derivatives for more than 25 years.

For more on this topic see:
Best Practices: Eliminating Direction | Delta as a Hedging Tool: April 18, 2016



Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Related Posts

tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com. 

tastytrade is a trademark/servicemark owned by tastytrade.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).

tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.

Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.

© copyright 2013 – 2022 tastytrade. All Rights Reserved. Applicable portions of the Terms of use on tastytrade.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastytrade’s podcasts as necessary to view for personal use.