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A related term, delta hedging, is the process of setting or keeping a portfolio as close to delta-neutral as possible. In practice, maintaining a zero delta is very complex because there are risks associated with re-hedging on large movements in the underlying stock's price, and research indicates portfolios tend to have lower cash flows if re ...
This is true because put-call parity posits a risk neutral equivalence relationship between a call, a put and some amount of the underlying. Therefore, being long a delta-hedged call results in the same returns as being long a delta-hedged put. Volatility arbitrage is not "true economic arbitrage" (in the sense of a risk-free profit opportunity).
An investment strategy or portfolio is considered market-neutral if it seeks to avoid some form of market risk entirely, typically by hedging. To evaluate market neutrality requires specifying the risk to avoid. For example, convertible arbitrage attempts to fully hedge fluctuations in the price of the underlying common stock.
However, maintaining a market-neutral position may require rebalancing transactions, a process called dynamic delta hedging. This rebalancing adds to the return of convertible arbitrage strategies. This rebalancing adds to the return of convertible arbitrage strategies.
A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, gambles, [1] many types of over-the-counter and derivative products, and futures contracts.
The main principle behind the model is to hedge the option by buying and selling the underlying asset in a specific way to eliminate risk. This type of hedging is called "continuously revised delta hedging" and is the basis of more complicated hedging strategies such as those used by investment banks and hedge funds.
Profit diagram of a box spread. It is a combination of positions with a riskless payoff. In options trading, a box spread is a combination of positions that has a certain (i.e., riskless) payoff, considered to be simply "delta neutral interest rate position".
The objective is to minimize risk due to the movement of the underlier's price, while implementing whatever strategy led to the sale of the options in the first place. For instance, a seller of a call may hedge by buying just enough of the underlier to create a delta neutral portfolio. As time passes, the option seller adjusts his hedge ...