What is delta hedging and how does it work in crypto?
Delta hedging is a strategy used in options trading to reduce the risk associated with price movements in the underlying asset.
It involves using options to offset the risk to either a single other option holding or an entire portfolio of holdings.
The goal of delta hedging is to reach a delta-neutral state, meaning the portfolio is not affected by price movements in the underlying asset.
Understanding Delta
Delta, represented by the symbol Δ, is a metric that measures the change in the price of an option's value, given a $1 change in its underlying asset. It often ranges from zero to one and can either be positive or negative depending on the option contract being a call or put.
The calculation of delta is typically based on the Black-Scholes model. Its numeric value can be derived by dividing the change in the value of the option by the change in the value of its underlying asset.
How Delta Hedging Works in Crypto
In the context of cryptocurrency, delta hedging can be used to mitigate the risk of price volatility.
For instance, if you own 1 BTC and you're unsure about BTC's price movement after an upcoming event, you can hedge against this portfolio with a current delta of 1 by buying put options with a delta of -0.4.
This gives an overall portfolio delta of 0 since the negative delta from the purchased BTC put options is neutralized by the positive delta of the BTC you own.
The Challenges of Maintaining a Delta Neutral Crypto Portfolio
Maintaining a delta neutral crypto portfolio can be challenging due to factors like changing implied volatility and theta decay. The hedge set up against the 1 BTC holding will likely become imperfect over time.
Options have dynamic deltas that constantly fluctuate because of gamma, which measures the rate of change of an option's delta per $1 change in the underlying asset.
This complexity requires crypto option traders to keep an eye on their positions in the long run.
Writing Delta Neutral Options Strategies
Delta neutral options strategies are used among options sellers who write contracts and aim to benefit when they expire out-of-the-money (OTM).
One example of such a delta neutral option strategy would be a short strangle. In this strategy, crypto options traders will look to sell the put contract and the call contract. This will create a delta neutral options strategy as the delta from the call contract is offset by the delta from the put contract.
The Final Word
Delta hedging is a complex strategy mainly used by institutional traders and investment banks. It requires a constant rebalancing of the hedge and a keen understanding of how crypto options work.
Despite its complexity, it can be a tool for advanced crypto traders to mitigate risk and receive compensation from writing contracts for any impending volatility.
