In Schweser I’ve only seen the delta-hedge by shorting (shares to hedge/call option delta) call options. How would this work with put options? Given that the put option delta will be negative, I wonder how would we interpret the resulting number of options to hedge the stock (in this case, long puts no?)
Think of it like buying portfolio insurance: you buy put options.
Best to buy far out-of-the-money puts.
I’m sorry sir but I don’t get it. Could we go with an example?
Let’s say that you have 10,000 shares of Company X stock, selling at $20/share. A $15 strike put has a delta of −0.25. So you buy 10,000 / 0.25 = 40,000 puts. If the stock price drops by $1/share ($10,000 total for the portfolio), the value of the puts increases by 0.25($1) = $0.25, so the total value of the puts increases by 40,000($0.25) = $10,000. Your portfolio value is hedged.
Thumb rule for delta hedging :
Opposite position if you are using call option i.e long call/short stock or short call/long stock
Same positions if you are using put i.e long put/long stock or short stock/short put
If you go to the CFAI EOC questions 4 and 5, they deal with this. If you refer to the answer, it will give you a better understanding.
Hope that helps.
Ok issue solved, my quesion came from the fact that put option delta is negative and Schweser did not specifiy to use absolute values. Even though it seems obvious, just wanted to confirm.
You can think of it this way: number of shares / delta:
- A positive number means that you sell a positive number of options (and they’ll be calls, because only calls have a positive delta)
- A negative number means that you sell a negative number of options, which is the same as buying a _ positive _ number of options (and they’ll be puts, because only puts have a positive _ negative _ delta)
Call options have positive option delta.
Put options have negative option delta.
Apparently I copied and pasted the line I wrote about calls, then forgot to change positive to negative.
I’ve corrected it.
Hi s2000 can u show an example where you sell put and sell shares? The max loss that u face when you sell a put is your premium right. So how does the delta hedge net 0 in this case?
Scratch the q. I figured it out.
Those are the kinds of questions I like the best.