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Adjusting Delta Hedges as Implied Volatility Changes

Article Quant Q&A · Author: confused
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Summary

The document asks whether an option buyer who initially delta hedges using the option’s implied volatility should keep using that original volatility or update the hedge as implied volatility changes. The response says accurate dynamic hedging requires adjusting the hedge as implied volatility and the option’s delta change over time.

It also notes that a covered option position can face added hedging risk when markets move sharply or liquidity is poor. In those conditions, executing adjustments may become harder even as large moves make hedging more consequential. The exchange offers a practical direction rather than a formal derivation: it does not compare fixed-volatility and changing-volatility hedge rules quantitatively, nor specify a rebalancing schedule or account for transaction costs and model error.

Key ideas

  • A dynamic delta hedge needs to reflect changes in implied volatility and option delta.
  • Holding the original delta hedge fixed can leave exposure as market conditions change.
  • Sharp price moves and weak liquidity can make hedge adjustments more difficult and more consequential.
  • The discussion does not quantify hedge performance or prescribe a rebalancing frequency.

Tags

OptionsDerivatives pricingVolatilityRisk management
Full text
# In literature, is IV constantly adjusted during option delta hedging?


# In literature, is IV constantly adjusted during option delta hedging?












In a lot of literature, they like to compare the performance of buying an option, and then delta hedging either at that options implied volatility (IV) or the true future volatility. This is under the BSM framework.

My question is for the former case. Let's assume the option IV is 20% and the true future volatility is 30%. We buy the option at 20% IV and delta hedge using 20% IV. As we move forward in time, if the option that we bought has an IV that changes, let's say now it is at 25% IV. Do we now delta hedge at 25% IV or do we continue to hedge at 20% IV? The literature never makes this part clear.

Thanks!

## Answer by Chris (score 1)

https://quant.stackexchange.com/a/47026

You need to hedge dynamically (ie, with changes in IV/delta) to accurately hedge your position. This also winds up being a potential risk for a covered option position if there are big moves or general lack of liquidity, since it can be more difficult and also more important to hedge at those times given large market moves.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.