Could anybody tells me the answer of this question? When a delta neutral hedge has been established using call options, which of the following statements is most correct? As the price of the underlying stock: A) increases, some option contracts would need to be repurchased in order to retain the delta neutral position. B) changes, no changes are needed in the number of call options purchased. C) changes, no changes are needed in the number of call options that are written. D) increases, some option contracts would need to be sold in order to retain the delta neutral position.
D?
So I guess we’re short call options hedging a long position in stock (but ambiguous). As stoc price increases delta of calls gets near 1 so we always move toward a 1-1 stock/call ratio. That means sparty’s right.
JD…u made my day !!!
Yep it is. Oops. Coffee issue, I guess.
Good question. Yes its A. To establish a hedge with call options: Write 1/delta call options for every unit of the underlying you hold. If price of the underlying goes down, your short position in the option goes up in value to compensate. Equally, as the price of the underlying goes up you loose on the short postion in the call. However, as the price goes up, the call moves further into (or closer to the money), its gamma falls and delta moves closer to 1 (because the further into the money the option becomes, the smaller the time-value becomes in relation to intrinsic value - intirinsic value moves 1 for 1 with changes in the underlying - so the option price starts to move much more closely with the price of the underlying (delta approaches 1). Also the more accurate delta remains over price changes and gamma falls) If delta moves closer to 1, then you need less options per unit of the underlying to maintain the hedge (because each individual option captures a greater % of the movement in the underlying) Because you’re short the option, you need to repurchase some of your short positons to reduce the number of outstanding options per unit of underlying and maintian an effective hedge -hence A.
great! I need to read this a few times.
Robert0s, I believe you can pass without doubt. Thanks.