Optimal Delta Hedging for Options

33 Pages Posted: 9 Sep 2015 Last revised: 18 Sep 2017

See all articles by John C. Hull

John C. Hull

University of Toronto - Rotman School of Management

Alan White

University of Toronto - Rotman School of Management

Date Written: May 24, 2017

Abstract

The “practitioner Black-Scholes delta” for hedging options is a delta calculated from the Black-Scholes-Merton model (or one of its extensions) with the volatility parameter set equal to the implied volatility. As has been pointed out by a number of researchers, this delta does not minimize the variance of changes in the value of a trader’s position. This is because there is a non-zero correlation between movements in the price of the underlying asset and implied volatility movements. The minimum variance delta takes account of both price changes and the expected change in implied volatility conditional on a price change. This paper determines empirically a model for the minimum variance delta. We test the model using data on options on the S&P 500 and show that it is an improvement over stochastic volatility models, even when the latter are calibrated afresh each day for each option maturity. We present results for options on the S&P 100, the Dow Jones, individual stocks, and commodity and interest-rate ETFs.

Keywords: Options, delta, vega, gamma, minimum variance, stochastic volatility

JEL Classification: G13

Suggested Citation

Hull, John C. and White, Alan, Optimal Delta Hedging for Options (May 24, 2017). Journal of Banking and Finance, 82, September 2017, 180-190., Available at SSRN: https://ssrn.com/abstract=2658343 or http://dx.doi.org/10.2139/ssrn.2658343

John C. Hull (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
(416) 978-8615 (Phone)
416-971-3048 (Fax)

Alan White

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-978-3689 (Phone)
416-971-3048 (Fax)

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