Delta-Neutral Hedging Decay

Delta-Neutral Hedging Decay refers to the gradual erosion of a portfolio's market-neutral status over time. When a trader holds a position that is delta-neutral, they are theoretically immune to small price movements in the underlying asset.

However, as the price changes, the delta of the options positions shifts, meaning the portfolio is no longer neutral and becomes exposed to directional risk. This requires constant rebalancing or hedging.

Decay occurs when the cost of rebalancing ⎊ due to transaction fees or market impact ⎊ outpaces the protection provided by the hedge. It is a critical consideration in high-frequency trading and algorithmic market making within the derivatives space.