Hedge Ratio

A hedge ratio is a number that tells you how much of one instrument you need to hold to offset the price risk of another. In options trading it is most often used to describe how many shares of stock you'd need to buy or sell against an options position so that, for a small move in the stock, the combined position barely changes in value.

For a single call or put option, this number is the same as the option's delta. Delta measures how much an option's price is expected to move for a $1 move in the underlying stock, expressed as a number between 0 and 1 (or 0 and -1 for puts). If a call has a delta of 0.60, its hedge ratio is 0.60, meaning you'd need to be short 60 shares of stock for every 100-share-equivalent call contract to offset the option's directional exposure at that instant.

The nuance that trips people up is the word "theoretically" and the word "instant." A hedge ratio built from delta only holds for a small move and a short window of time. Delta itself shifts as the stock price moves, as time passes, and as implied volatility changes, so a hedge that is neutral right now can become badly unbalanced an hour later. Traders and market makers who hedge this way have to keep re-calculating and re-adjusting, a process called re-hedging or dynamic hedging, rather than setting it once and leaving it.

Outside single options, "hedge ratio" is also used more loosely for other pairs of instruments, such as how many futures contracts offset a bond portfolio, but the options-delta usage is the one beginners run into first.