Chapter 05 · Section 5.1

Delta Factor - At-The-Money-Put

Suppose the stock was at 100 and that the hedger considered an at-the-money put with a premium of 5. With a delta factor of -0.5, these are the results of the hedge:

     Stock price         Put value       =         Total value
         98              2 x 6                         110    
         99              2 x 5.5                       110    
        100              2 x 5                         110    
        101              2 x 4.5                       110   
        102              2 x 4                         110

The delta hedge compensates for price changes and keeps the total value constant. In the example the delta factor is assumed constant for the range 98 to 102. In reality it is not, which means that the effectiveness of the hedge decreases the further the price moves from the price at which it was calculated. The hedge should have been rebalanced after each price change.