Report on Delta-Gamma Hedging

1. Introduction Delta-Gamma hedging is a risk management strategy commonly

used in the financial industry, particularly in options trading. This report aims to
provide an overview of Delta-Gamma hedging, its purpose, and its benefits in
mitigating market risk.
2. Understanding Delta and Gamma Before discussing Delta-Gamma hedging, it is
crucial to understand the concepts of Delta and Gamma:

2.1 Delta: Delta represents the sensitivity of an option's price to changes in the price of
the underlying asset. It measures the change in the option price for a one-unit change in
the underlying asset's price. Delta can be positive or negative, depending on whether
the option is a call or a put option.

2.2 Gamma: Gamma measures the rate of change of an option's delta in response to
changes in the price of the underlying asset. It indicates how much the delta of an
option will change for a one-unit change in the underlying asset's price.

3. Delta-Gamma Hedging Strategy Delta-Gamma hedging is an extension of delta

hedging, which involves adjusting the delta exposure of an options portfolio to
neutralize the impact of small price movements in the underlying asset. Delta-
Gamma hedging goes a step further by incorporating the gamma component
into the risk management strategy.

3.1 Purpose of Delta-Gamma Hedging: The primary objective of Delta-Gamma hedging

is to reduce the overall risk exposure of an options portfolio by dynamically adjusting
the delta and gamma values. By hedging against both price movements (delta) and
changes in price volatility (gamma), traders can seek to maintain a more balanced and
neutral position.

3.2 Benefits of Delta-Gamma Hedging: a) Reduced directional risk: Delta-Gamma

hedging helps minimize the risk associated with price movements in the underlying
asset by adjusting the delta exposure. This ensures that the portfolio remains relatively
insulated from market fluctuations.

b) Volatility management: Gamma captures the sensitivity of the option's delta to

changes in price volatility. By actively managing the gamma exposure, traders can
respond to shifts in market volatility, potentially benefiting from increased option
premiums during high-volatility periods.
c) Improved risk-adjusted returns: Delta-Gamma hedging allows traders to optimize
their risk-reward profile by actively managing the portfolio's exposure. It enables them
to adapt to changing market conditions and capture profit opportunities while
mitigating downside risks.

4. Implementation of Delta-Gamma Hedging Implementing Delta-Gamma hedging

involves regularly rebalancing the options portfolio to maintain a desired delta
and gamma exposure. This process typically includes the following steps:

a) Initial hedging: The trader establishes a position in options and calculates the initial
delta and gamma values of the portfolio based on the option positions.

b) Monitoring: The trader closely monitors the market and tracks changes in the
underlying asset's price and implied volatility.

c) Adjusting delta: When the underlying asset's price changes, the trader adjusts the
portfolio's delta exposure by buying or selling the underlying asset or its derivatives to
bring the delta closer to zero.

d) Adjusting gamma: If there are significant changes in price volatility, the trader adjusts
the gamma exposure by buying or selling options to maintain a desired level of risk.

e) Rebalancing: Regularly rebalancing the portfolio is necessary to ensure that the delta
and gamma remain within the desired range. This step involves repeating the previous
steps as market conditions evolve.

5. Conclusion Delta-Gamma hedging is a sophisticated risk management strategy

that combines delta and gamma adjustments to mitigate market risk in options
trading. By actively managing the portfolio's exposure to price movements and
volatility, traders aim to achieve a more balanced risk-reward profile and improve
overall performance. However, it is important to note that Delta