Delta hedging with the smile

Abstract

This paper shows that the delta hedging performance of the Black-Scholes model can be substantially improved with a rather simple adjustment of the Black-Scholes delta. By utilizing the volatility smile, the Black-Scholes delta can be adjusted to account for the inverse movements between volatility and stock prices. Empirical tests in the FTSE 100 index option market show that the smile-adjusted delta consistently outperforms the Black-Scholes delta in terms of hedging performance.