Investors can trade volatility skew two ways
Option price = Intrinsic value + Time value
For simplicity, this article will consider implied volatility of options with expiry dates in 3 months and 12 months.
Professional option traders very often use terms such as flat and steep volatility skew in conversations. There is no clearly defined rule for calculating the volatility skew, as it will depend on the expiry date and moneyness of options that trader wants to use to determine the skew (Read Rules for Trading Volatility skew).
Delta hedging is one of the ways to reduce the risk of an option position, aimed at reducing the sensitivity of the derivatives portfolio to small fluctuations in the price of the underlying asset. Frequent delta hedging is a typical task for traders who specialize in options with expiry dates of up to one month.
Δ = δV/δS
Trader can buy or sell the underlying asset in order to hedge delta of an option position. Now we will analyze the principle of delta hedging in more detail and show an example of gamma hedging.
Definition. Option is a derivative financial instrument, it is a contract sold by one counterparty (option writer) to another counterparty (option buyer).