Two questions on Schweser Exam 1 PM - Ethics & Derivatives

CFA Level III
#1

  1. Why B and not C? The answer explanation says nothing about accepting / not accepting the account without full knowledge of West’s other accounts. To me, this phrase in the answer choice is referring to the fact that he is promising West that DIS will have no problem managing all of West’s accounts, even though West has private equity investments that DIS is not equipped for.

  2. The answer choice says “In a delta hedge, a short position in call options is offset with a long position in the underlying security (or vice versa).” By “vice versa”, I assume this means a long position in stock offset with a short position in calls. But isn’t this a covered call strategy and if so, is it accurate to say that a covered call is a type of dynamic hedging strategy, as described above, where calls must be continually bought and sold?

Thanks.

#2

any help?

#3

I just started studying and I dont have the material, however what I am thinking regarding 47 , in a delta hedge what you are trying to do is keep the value of your position fully hedges, ie when stock price goes down, the value of the calls you are short will go down by just as much, and thus your net position is the same…

however when you do a covered call, for prices below the strike price the value of your position will change, above the strike price, the most your position will be worth is the strike price, but below the strike price you are exposed to losses, so you are not hedged with a covered call

i am not sure why would you call a covered call dynamic hedging,

just trying to pick up the pace and contribute.

#4

I had previously thought that a covered call is being long a stock and shorting calls in order to make some excess income, in the expectation that stock prices will remain constant. I thought this was different from dynamic hedging, because in dynamic hedging, you have a bunch of naked short calls that you want to hedge by constantly buying and selling shares of stock.

So my confusion was the portion of the answer that said that a dynamic hedging strategy can be a short position in calls offeset with a long position in underlying, or vice versa.

This is what leads me to think that a covered call strategy can also be classified as a dynamic hedging strategy, where it is the # of calls that are actually constantly adjusted for the long stock position.

#5

Brokercfa is correct . The objective of covered call strategy is not to hedge . Quite the contrary . It is to gain exposure in the expectation of earning a decent return.

The objective of delta hedging is to reduce exposure.

also the costs incurred in dynamic delta hedging would be much more , because of a frequent need to reestablish the hedge

#6

I agree with you. That is exactly what is leading to my confusion in the sentence from the exam answer choice: “In a delta hedge, a short position in call options is offset with a long position in the underlying security (or vice versa).”

They go on to explain how to calculate the nuber of call options to short per share of the underlying stock, which is 1/delta.

So perhaps the implication is that you can achieve the delta hedge in two ways–either to 1) continually buy/sell shares and hold your short call position or 2) continually buy/sell calls and hold your stock position.

So its two different ways of looking at the delta hedge, and covered call has nothing to do with this.

Do you agree?

#7

The covered call position is when you have -#Shares of Stock/contract size and the delta hedge position would be -1/delta. the difference here being the # of contracts you would enter to establish the position, and then of course the fact that you would need to continually readjust the delta hedge, whereas for the covered call is a set-and-forget type of strategy.

I would say they are two separate strategies, but are established with the same securities, just in different proportions, and different monitoring post initiation.

#8

definitely agree. my only point was that a dynamic hedge can actually be achieved in 2 different ways

  1. hold short calls and constantly buy and sell the underlying stock to keep the hedge

  2. hold the stock and constantly buy sell calls to keep the hedge

that is what was meant by the “vice versa” in the answer key.

i believe this is right, let me know if you disagree.

#9

You are right , you can own a stock position or you’re on the right side in a lucrative derivative position . Either way you want to protect your gains until some maturity date and perform delta hedge activity . Could be costly though , so it better be worth it or the duration should be very short.