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I'm fairly new in this field so if I make a mistake please correct me. I have a beginners question about hedging.

The delta of a put option is always negative so to delta hedge a put option I would have to sell the underlying stock. This means that if I would buy a put option while I don't have any stocks in my possession I would first have to buy the stocks to be able to hedge my put option. But buying and selling the stocks to hedge is a zero operation.

Does this mean that to be able to hedge a put option you should already be the owner of an amount of the underlying stock?

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so to delta hedge a put option I would have to sell the underlying stock

(actually you would buy the underlying stock to offset a negative delta, not sell it)

Not necessarily. You could also buy calls at the same or different strikes (which creates a straddle or strangle). But yes, you could buy some amount of the underlying to increase delta back towards zero, or buy call options (you could also sell puts at different strikes, but that tends to cancel out more of the original position).

Note that delta is only one risk factor associated with options. There is also risk to changes in delta (gamma), volatility (vega) and, to a much less extent, time (theta) and interest rate (rho). So by hedging delta you might be inadvertently increasing risk to some other factor.

  • I would add to D Stanley's point that you also need to consider the transaction costs associated with constantly hedging. The tx costs for buying the underlying, as you've described, are probably less than what it would cost to hedge delta via options but it is still worth considering. – HK47 Aug 8 '18 at 15:27
  • Hedging delta will always increase risk because either the hedge will diminish potential profit or add risk in the other direction. It's not unusual to hedge put options. Many people prefer the risk management of vertical spreads over the asymmetric risk of naked puts (or the equivalent covered call). – Bob Baerker Aug 8 '18 at 17:38
  • It's certainly less common that, say, using puts to delta-hedge a long stock position, no? – D Stanley Aug 8 '18 at 18:43
  • I'm not sure what the "it" is. Verticals are less common than using puts to hedge long stock? If so, I can't give you an unequivocal answer. The best that I can offer is that retail doesn't usually delta neutral trade since it's more complex, involves many transactions and is commission intense, making it very difficult than for pros. A market maker is a different story since he buys at bid, sells at ask, has higher margin and other benefits. I would consider it using stock to hedge the options since you can fine tune with any amount of shares but a standard contract is always 100 shares. – Bob Baerker Aug 8 '18 at 19:38
  • My claim was that using something else (e.g. stock) to hedge a put option position is less common than using put options to hedge something else. "Unusual" may be too relative a term. In any case it's not relevant to the original question, so I've removed it. – D Stanley Aug 8 '18 at 19:45
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Yes, the delta of a put is always negative but you have two choices with options - you can buy them or you can sell them. If you buy them then you own negative delta. If you sell them then you "own" positive delta.

Owning positive delta may seem a bit confusing since it's a short put. That short put represents the obligation to buy the stock and the delta of long stock is positive. Is your head starting to spin yet?

To be more specific, if you are long the put (negative delta) the simplest delta hedge would be to buy stock. Conversely, if you were short the put, shorting stock would be the delta hedge.

You can delta hedge in a variety of other ways. For example, in a Reverse Ratio Spread (aka a Backspread), you would sell an option and buy more of them at an OTM strike.

You can also buy or sell calls to hedge puts and vice versa but these are more sophisticated strategies that have a variety of other risks and should not be attempted unless under the supervision of an adult :->)

After you understand this well, if you attempt any of this, make sure that you are trading at a deep discount broker that charges less than $1 per option contract. Using a traditional $4.95 per trade (perhaps plus a per contract fee as well) will kill you.

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