How Does “Delta Hedging” Relate to the Liquidity Needs of an Options Portfolio?

Delta hedging is a strategy used to neutralize the directional risk (Delta) of an options portfolio by taking an offsetting position in the underlying asset. This strategy requires the ability to quickly and frequently trade the underlying asset.

Therefore, delta hedging demands high liquidity in the underlying market. If the underlying asset is illiquid, the trader cannot rebalance their hedge efficiently, leading to "slippage" and increased transaction costs, which compromises the effectiveness of the hedge.