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EducationalJanuary 13, 2021

Crypto Options Trading: Understanding Delta and Gamma Hedging

Shubham Goyal
Product Specialist
January 13, 2021

Delta and gamma hedging are both crypto options trading strategies traders use to mitigate the risks associated with changes in cryptocurrency prices. With this post, we intend to give you a clear understanding of the concepts of delta and gamma hedging for all your crypto trading needs. But let’s first understand what ‘hedging’ constitutes, shall we?

What is Hedging?

Most cryptocurrency derivatives exchanges like Delta allow a trader to manage their financial risks by letting them lock in a fixed price upfront. This gives them a layer of protection against fluctuations in the ever-shifting crypto prices, as they can continue to pay that fixed price even when the actual market price of cryptocurrency changes. This risk-minimizing trading strategy is known as hedging a position, so hedging basically enables traders to safeguard their investments.

However, one thing you must keep in mind: hedging is only a means to lower the risks against market volatility, it doesn’t help to gain more profits. Therefore, by using hedging, you cannot make any extra profits out of crypto options trading; instead, you can maintain a stable value of your underlying asset over unpredictable market conditions.

Now that the basics of hedging are out of the way, let’s jump into detailed discussions of delta and gamma hedging, and the differences between the two!

So, What Is Delta Hedging?

Delta hedging is a crypto options trading strategy that looks to mitigate – or hedge – the directional risks that come with price movements in an underlying asset. In simpler words, delta hedging attempts to neutralize the extent of the move in a crypto option’s price, compared with the underlying asset’s value. In crypto options trading, Delta represents the change in the price of an option contract on a par with the shift in the price of the underlying asset.

Delta hedging requires the trader to constantly readjust and balance the fixed price promised as a hedge. It’s pretty complex to maintain; and therefore delta hedging is a trading strategy used primarily by experienced and institutional traders.

Should You Go for Delta Hedging? What are the Cons Involved?

A pretty basic issue with delta hedging is that you would have to watch your crypto options trading position like a hawk so you can adjust your hedge whenever the underlying crypto’s price moves up or down. In case you fail to do so, your position stands at the risk of being under or over hedged.

Depending on the movement in the underlying asset’s price, all the buying and selling a trader has to do to adjust their hedge also means there’s a large number of transactions a trader has to perform when delta hedging. This can be quite expensive due to all the trading fees incurred.

Additionally, a problem with crypto options trading is options can lose value as their expiry dates draw nearer. Options with more time value typically have higher premiums than the ones with lesser time left to expiration, therefore for an option that’s nearing it’s expiry date, there might arise the need for increased delta hedging to keep the investment safe.

However, despite the drawbacks involved, delta hedging is the best way to go about your crypto options trading when you anticipate a strong movement in the market price of your underlying asset. Aside from letting you protect your investment from adverse price changes, delta hedging can also safeguard profits from your option position in the short-term without perturbing your long-term holding.

Got It! Now What Is Gamma Hedging?

As mentioned before, an option’s price moves drastically right before its expiration. This is where gamma hedging comes in: this particular crypto options trading strategy looks to neutralize the price shift that comes before an option’s expiry.

In crypto options trading, Gamma refers to the rate of change of the Delta. Gamma hedging can also be availed to reduce the risks an options trader faces when the underlying security’s market price unexpectedly makes large moves in either direction. It can be said that for a crypto trader, gamma hedging is the next line of defense right after delta hedging.

Delta and gamma hedging are strategies that can be used on their own while crypto options trading, or they can be combined to safeguard a trader against the risks of movements in the prices of an underlying asset and in the Delta itself. This crypto options trading strategy that combines both delta and gamma hedging is simply called the delta-gamma hedging.

Differences Between Delta and Gamma Hedging:

While delta and gamma hedging are intricately linked concepts, there still are some considerable differences between the two.

In both crypto options trading strategies, a trader is trying to hedge their investments by buying and selling options. Delta, however, is the first derivative of the option’s value with respect to the underlying asset’s market price, while Gamma is the second derivative. Therefore, Delta is the change in the option’s price keeping with the underlying asset’s changed price. On the other hand, Gamma is the shift in the option’s Delta caused by the changed price of the option.

In crypto options trading, delta hedging provides protection against relatively smaller changes in the underlying asset’s market price. However, gamma hedging provides protection against both small and large changes in an underlying asset’s prices.

And there you have it! We hope this blog post has helped you grasp the basics of the delta and gamma hedging strategies!

At Delta exchange, you can hedge your future revenues during crypto options trading, and lower uncertainties when it comes to your anticipated cash flow!

Happy crypto options trading!

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