Question

The delta of a trader’s portfolio is -2100 relative to the price of gold (per ounce). How much does the trader gain or lose if the price of gold drops $10? How can the trader become delta neutral by taking a position in forward contracts on gold? Explain why this works.

Answer 1

Delta measures the change in portfolio value for each unit change in the underlying price.

If the price of gold drops $10, the portfolio will gain in value (because delta of the portfolio is negative).

Gain = $10 * 2,100 = $21,000

The trader can become delta neutral by taking a long position in gold forward contracts. The number of contracts purchased should be such that the total delta of the forward contracts is +2100. This would make the trader delta neutral, as their net delta is zero.

If the gold price drops, the initial portfolio will gain in value, but the forward contracts will lose. If the gold price rises, the initial portfolio will lose value, but the forward contracts will gain in value. Thus, the trader's position is delta neutral, i.e. changes in gold price will not affect the net portfolio value.