Delta Hedging

Delta hedging is the practice of offsetting an option position's exposure to the underlying rate by holding a position in the underlying itself, sized to the option's delta. A dealer who has sold options does this continuously rather than once, because delta changes as the rate moves and as time passes, so the offsetting position has to be adjusted repeatedly over the life of the contract. It is the mechanism by which the options market reaches the spot market. Adjusting a hedge means buying or selling the pair, and those trades are not opinions about direction — they are a consequence of a position and a model. This is why option-related flow is often described as buying into weakness or selling into strength around particular levels, and it is also why that description is an explanation offered after the fact rather than something visible in advance. Over-the-counter option positions are not published, so any claim about where hedging flow sits is an estimate, and the standing of whoever made it is the thing to weigh rather than the confidence with which it is stated.