An increase in the price of the underlying increases delta, so the size of a delta hedge call position should be decreased. What am I missing here how is this correct?
I think you are right. - sticky
In the material…or think your self as a option dealer. You use stock to hedge your outstanding options. You are right, you can balance a delta hedge via option or stock. However, in this case, you are using stock to keep the hedge in check. So, when stock price go up, it increase the delta, therefore, as an option dealer, you need to buy more shares of stock to maintain the hedge. Make sense?
Yea that makes sense, so ws you disagree with the above statement? I don’t understand why you would decrease your call position if delta goes up. This is a schweser questions they claim is correct.
if you’re an option dealer, you sell someone a call, delta increases on the call… you buy more shares to be hedged (delta neutral)
wait does anyone agree with the first statement that you shoud decrease your position? Or can someone just explain to me question 18.2 on schweser vol 1 exam 2?
I think the disconnet b/t schweser and the comments above is that delta hedging isn’t only for options dealers. If you own stock, for example, you can delta hedge by selling 1/delta calls. If the price goes up, the delta increases on the call, and you need fewer calls to remain hedged. Sounds like that may be the scenario schweser is talking about.
s23dino…we don’t disagree (we agree) that your first statement is correct. Equation==>#option=#stock/delta. Yes, as delat go up, ONE of the WAYS to keep the hedge is to reduce the # of options.
At the risk of sounding argumentative, this case (I believe) only applies to a situation when an option dealer is short call options. The increase in the price of the underlying necessarily results in higher valuation for the option position because it either moves closer to being in the money or deeper in the money (in relation to X). However if the delaer is short put options, the situation is reversed.
Input, not sure what you mean by this case only applying to a dealer. Can you clarify? If a dealer is short calls, then to hedge they can either: (i) enter into an offsetting long call position with an option seller, or (ii) delta hedge with the underlying. The question asks about adjusting the number of call options, not the number of shares. That’s what leads leads me to believe that they’re talking about somebody long the underlying putting on a delta hedge rather than an options dealer who is short calls. If you’re saying that only a dealer would use a delta hedge, that’s not correct.