Can someone explain to me what does the word “size” refer to in Schweser’s explanation, and why it should be decreased. “An increase in the price of the underlying increasese delta (OK here), so the size (??) of a delta hedge call position should be decreased.” Maybe then I will understand why is should be decreased. I’m not exactly following this explanation. I do agree, that when price of underlying increases so does delta.
hedge = s/delta
yea the hedge is 1/delta * #stock so if at first you have a delta of .4 you would do 1/.4*100=250 calls, if delta increases to say .6 then you would have 1/.6 *100= 166.67, so your call positions decreases.
s23dino - I agree, you should have fewer calls. In that Schweser example the original number of calls sold was 125 to hedge the position in Treasury bonds. The delta increased, hence the number of calls sold is too many. However, where my confusion arises is from the examples so far I’ve seen you adjust the delta hedge by changing the amount of stock you hold, you either sell off some stock or buy more to maintain the hedge. So, in this case they should buy some more underlying to delta hedge. I think I understand what is meant by “call position” should be adjusted (down), but again, this is not how I understood delta hedging works. It should be adjusted by changing the amount of underlying, unless I missed something.
you can do it either way depending if you are looking to hedge your the stock position or your call position. if you have a stock/bond position you can hedge with calls if you have call position you hedge with stock/bond.
Correct me if I’m wrong but isn’t a DELTA HEDGE position where you actually buy stocks or sell stocks to hedge your position in the options? So if the price of the stock rises, that would increase Delta. As a result, you would need to buy more stock to hedge the position. That said, I can see how it would still work the other way around as well where you have a position in stocks and want to hedge it using options. In that case you would just divide the stock position by delta to arrive at the # of options required. I think that’s right… lol
It works both ways – options to hedge stock or stock to hedge options. Same name. Same technique.
Thanks “MaxTheDog” & “s23dino” for clearing this up for us. I think PJStyles was also in the same boat as me, since both CFAI and Schweser only show you how a dealer hedges their written options. That’s where my confusion arose.
like MaxThe Dog said it works both ways: if you sell calls, you buy stock if you buy calls, you short stock if you sell puts, you short stock if you buy puts, you buy stock if you buy stock, you can either sell calls or buy puts if you short stock, you can either buy calls or sell puts
VolkovV …This makes me sick Seriously, good stuff.