Illustrates an example of delta hedging

Question

Illustrates an example of delta hedging.

Answer 1

The ‘underlying’ within a delta-hedged portfolio could be a traded asset, for illustration, a stock or it could be other random quantity that finds a price such as a risk of default. When you have two instruments depending upon the same risk of default, you can compute the sensitivities, the deltas, of their prices to this quantity and after that buy the two instruments in amounts inversely proportional to such deltas (one long, one short). It is also delta hedging.