Gamma n delta hedging

[maxmeomeo]

Can anyone pls shed some light on why when gamma is large delta hedging is not effective?

 

[lemiman]

because when gamma is high (option at the money or near at the money), then delta is more sensitive to change is stock price. when delta changes, you need to adjust your hedge.

 

[maxmeomeo]

Effective is the word I quote from a mock, it said ..”limit the effectiveness of delta hedging”

 

[Jmachine4]

I think you set if you know the concept. I don’t know exactly why effective duration is best used for small changes in interest rates, but I don’t think thats what they are testing.

 

[BayStreet]

gamma measures how much the delta changes for a given change in stock price.
the point of a delta hedge is to create a position that is insensitive to changes in the asset price. You create this position using the delta. if the delta changes, you need to rebalance, the more the delta changes, the greater the extent of the rebalancing. hence when gamma is large, delta is volatile and more rebalancing is necessary making it a costly and not such an effective strategy.
remember an effective hedge value would ideally exactly offset the movement in the asset. won’t happen if you dont have the necessary stock/option ratio.

 

[maxmeomeo]

Great, thanks Baystreeet