A hedging technique which is used to provide insurance for a portfolio of investments by limiting exposure to delta or gamma. To that end, an option-like return pattern is usually drawn by fine-tuning the position in the underlying (or the derivative position on that underlying) in a way that matches the delta change in value of an option position. In other words, the hedge should be frequently adjusted in tandem with the changes in the underlying in order to offset the deltas of an actual position with those of a simulated one. More specifically, a trader may establish a delta hedge of a non-linear position, such as an exotic option, with a linear position, such as a spot transaction. The deltas of the linear and non-linear positions cancel out each other, and the whole position is said to be hedged. However, changes in the value of the underlying would require taking out more linear positions to offset the increasing delta of the non-linear position.

Dynamic hedging is commonly used by derivatives dealers who hold vast numbers of short options on a underlying and want to offset that position by taking long option positions on the same underlying since such long options are not always available at market. For example, a short position in index futures may be adjusted to create a synthetic put on a portfolio. By doing so, an insured-return pattern is simulated.