What is Delta Hedging || Dynamic Delta Hedging like a Quant || Profit & Loss Options Trading

Today we look at hedging options from a quant’s perspective. In this video we look at the difference in Profit and Loss (P&L) with three different strategies: dynamic delta hedging, static delta hedging and no delta hedging.

Delta hedging is a way to reduce directional risk of the underlying to your options positions by transacting in the money markets (bank account) and the underlying (stocks/futures/etfs/index). By continually adjusting in the underlying and bank account, we can effectively replicate the changes in payoff of the ‘new’ option contract. Essentially instead of betting on the direction at one time spot (on entry) we are now making a series of bets at different levels.

Hopefully in this video the importance and relevance of realized volatility becomes apparent and hence why market marking firms like Optiver are so keen on forecasting realized volatility as accurately as possible.

★ ★ Code Available on GitHub ★ ★

00:00 Intro
00:22 What is Delta Hedging?
01:40 Importance of Realized Volatility
02:00 Real world examples
03:56 Full worked example: Short CBA Nov 102 Call
06:40 Looking at P&L over 1000 trades
07:45 P&L distributions for different hedging strategies

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[bbqchickenlemon]

you've taught me more than my prof with a PHD ever could

[deepdivestocks]

Fantastic recap of hedging and its applicability in real-world trading.

[christianhjerrildblom]

Your videos are amazing, I'm currently doing a Bsc in mathematical finance and these videos are so inspiring to me. Keep up the good work!

[Lukas-cmb]

you made it look very easy that with hedging you almost not lose any money eg the low P5, but if the price dips 50% then your long shares are in 50% loss so i am not really sure about that profit distributions.

[wetradealerts]

Hey! I have a question. On your code, the number of weeks is set to 11. The option had an expiry of appx 2 months and you had converted that to years and divided by 11 to get each time step. My question is, if i take smaller time steps and delta hedged, lets say instead of 11, I delta hedged every day, lets say instead of 11, i put 100. Will the P/L distribution of delta hedge flatten out and be close to 0 ?

[kaiwang]

Thanks for the excellent video, you make it so easy to understand!

[olivermohr]

How do you model the delta in your simulation? You can simulate a random walk with a previously set volatility, but then you need market volatility to calculate the delta on each step. Which vol do you use there?

[ghostwhowalks]

This is super-useful! Silly Q - how do you control the change the hedge frequency from say monthly to weekly (daily you keep the number of steps constant and only change the time step; "dt"? Thanks!

[maurohalpern]

I am just buying low volatility and selling hi volatilty at same time using different stocks of a profitable; for me makes more sense "hedging" each leg of my cheap options with expensive ones, not using the stock itself

[fminc]

Thanks for your work, great channel. (ha ha ha, you slipped when you explained the short at 1:30, but thats all good, well explained as such).

[poorbadger]

How were you calculating P5, P95, mean - via Monte Carlos Analysis?

[junchenggeng]

when you calculated the original stock pnl, why is 102.59-102 instead of 102.69-102 @5:59

[carrotblog]

set the speed to 0.75 is much better :))

[Freewill]

Hi Jonathan, I happen to find your channel and would like to know whether you upload a video subsequent to understand market maker to explain how they predict the realized volatility. If you do can you let me know which video is it? Thanks!

[_el_yeyo]

I assume the simulations are based on Black Scholes for the profit calculations?

[josephwehby]

Is there an advantage or disadvantage to rebalancing your deltas daily versus weekly?

[mathieusaussez]

Short selling is you sell when the price is high to buy it low

[martinluther]

Hi, could someone tell me the name of the chair you use?

[janegoodall]

At 4:28 you state you have to immediately buy 54 shares to be delta neutral. But The very first adjustment you make in week 1 is entering a short position making the account -3 of the stock? But if you bought 54 shares immediately when you sold the call, wouldn't you still be long 51 shares of the stock?

If the delta changes by 3 week 1. Then how come when you start with 54 shares its not 54 - 3, but 0 - 3?

[MrLisaFischer]

Oh lord, why do I find Option trading so difficult. Where can I obtain introductory lessons on Options trading, all that Gamma and stuff😵