Static hedging versus delta and gamma-delta hedging strategies

Static Hedging Intro

Intensifying globalization has created tremendous opportunity for the world's corporations and investors. Yet, it has also resulted in increasing risk. As the number of financial transactions continues to proliferate, demand for ever-increasing hedging strategies has grown as well. As the world's markets become more intertwined, they have become more volatile, as changes in one region trickle throughout the global economic system. In response to this, hedging strategies have become more complex.

Where a simple static hedge may have sufficed in the past, risk managers now understand that this type of hedge may not cover their entire exposure with respect to their investment positions. This project attempts to compare static hedging strategies with delta and delta-gamma strategies. A static hedge is a position that is set and then maintained. A delta hedge attempts to remove all volatility in the position with respect to changes in the value of the underlying asset. A gamma-delta hedge goes further, not only offsetting the current delta but the change in delta over a wide range.

Every hedging strategy has costs. For risk managers, transaction costs of complicated options strategies may outweigh the potential benefits. Not every position, after all, needs to be perfectly hedged. This paper will examine the differences between static hedges, delta hedges and gamma-delta hedges. The effectiveness of each of these hedge types will be tested during times of both low volatility and high volatility in the markets.