Jun 17

Delta neutral hedge is insufficient – 7 minute screencast

by David Harper, CFA, FRM, CIPM

FRM |

As long as gamma (which gives the rate of change of delta) is nonzero, a delta neutral hedge is only (instantaneously) temporary and must be re-balanced. Here is an example adapted from Hull's question 15.22. Specifically, assume position in options on the dollar/euro exchange rate has a delta of 30,000 and gamma of –80,000. We can instantly achieve delta-neutral by shorting 30,000 Euros (underlying asset, and a forward on the underlying asset, has delta of 1.0; futures contract on underlying has delta of nearly 1.0). But the hedge is short-lived:

Screencast:

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