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August 12, 2015 at 3:47 pm
May I ask about the option dealer part that short call option. Usually as an investor we will buy put option instead, but since you say option dealer traded option (which i think this is what you mean?), then they buy shares to hedge. Can I say that the option dealer actually earn the option premium as a seller from the buyer of the call option and hedge himself using shares, which the transaction fees shall be much cheaper than that of option premium?
John Moffat says
August 12, 2015 at 4:05 pm
As far as exam questions go, someone owning shares can use call options to hedge against the risk of movements in the share price (and form a delta hedge).
In practice it is more likely that it will be the option dealer (the person who sells the options) who creates a delta hedge by buying shares. Yes, the will receive a premium when they sell them, but remember that they have the risk of having to pay out to whoever bought them if the purchaser ends up exercising the option.
August 12, 2015 at 4:52 pm
So in practice, the option dealer will pay out to whoever bought them if the share price goes up so that the reason why the option dealer buy shares in case the prices goes up and they can sell the shares, am I right to say that Sir?
August 12, 2015 at 5:08 pm
That is correct 🙂
(Although do appreciate that in the exam, for calculations involving a delta hedge then you do it from the shareholders point of view (as in the example in the lecture). It is only in a written part of the question where it could be relevant to mention the above.)
May 19, 2015 at 9:39 am
Is it possible to explain me why N(d1) from ex 6 is fixed, when the share price is changing.
You are saying that Change of option price will change by Change of Share price x N(d1). But should N(d1) change as it is depending on the Share price?
Will appreciate your response.
May 19, 2015 at 10:35 am
Yes it will – it is just in the very short term that it is fixed. Over time it will change (and gamma measures the rate of change – although you cannot be asked to calculate gamma).
October 9, 2014 at 11:49 am
Thank you for the lectures. I have a question about eg.6 that Martin own only 1000 shares so how he can sell 4080 options, I mean how and when he got that much of call optin rights. Does it mean he can sell any number of options if so how he got that rights for options?. Please give me some explanation.
October 9, 2014 at 4:01 pm
Just as with so many financial instruments, you can buy first and sell later (in which case you make a profit if the price increases) or you can sell first and buy later (in which case you make a profit if the price falls). You do not need to already own any to be able to sell – it simply means that you have to buy at some stage later.
(The same applies to currency and interest rate futures, as you will see in the later chapters.)
October 10, 2014 at 10:20 am
It is clear, Thank you so much for your quick response.
April 24, 2014 at 6:29 pm
Would we have to factor in the size of the options contract, when calculating the number of contracts that we would need for a delta hedge?
April 25, 2014 at 9:39 am
Because you can only trade in options in fixed numbers (the contract size).
June 1, 2013 at 11:41 am
@IGOLO from the lecture its clear that you would sell a call option say today while the share price is high, implying even the call option would be high, then when the share price fall in that future, its also assumed the call option which you sold while prices were high’s price would fall, then you buy it back. making a profit. However the trick is in how many of the call options do you need to compensate you for the loss in (falling share prices), hence the simplified Delta Hedge!
It then in example 6 meant martin had to sell 4080 call option which would protect him against the future expectations that prices will fall!
In hind sight if the prices do indeed go up instead of fall , Martin’s share market value increases, and the call option which he sold at the time 0 when he thought prices will go down becomes expensive to buy back. its a give or take situation. Like insurance for your car. You insure thinking if you get an accident someone replaces your car, however if nothing happens to your car all your life the insurance co gains, but if you indeed smash it its replaced!.
This is interesting indeed.
November 20, 2012 at 1:24 am
if there are prospects that the future share price of an investment wld fall, is it advisable to get a pull or call otion…pls xplain
June 1, 2013 at 4:13 pm
If you own shares and you are worried that the price of the share might fall, then the most sensible thing to do would be to buy a put option (there is no such thing as a pull option 🙂 ). The put option will give you the right to sell the share at a fixed price. So…..if the share price does fall below that price, then you are protected because you still have the right to sell it at the fixed price.
December 10, 2015 at 5:20 pm
In video, example 6, you said that first we should sell a call option and then buy back.
But then you said in comment “If you own shares and you are worried that the price of the share might fall, then the most sensible thing to do would be to buy a put option..”
–> It makes me confused. Please explain for me!
December 10, 2015 at 7:30 pm
Selling a call option or buying a put option would both have the same effect in terms of hedging against a fall in the share price for an owner of shares.
In the exam you do what you are told to do, but in terms of creating a delta hedge we sell a call option (and as I explain in the lecture, in practice that is because dealers selling call options are creating the delta hedge to protect themselves).
November 1, 2012 at 7:34 pm
Thank you :-), I’m going back to the lecture.
November 1, 2012 at 2:29 pm
I love your lectures, really very well explained, so thank you very much.
I have a question in relation to Delta Hedge, it assumes that only current MV of share changes, but N(d1) is constant. How could it be when we use Current MV of shares in calculations of N(d1), so it should change as well.
November 1, 2012 at 4:45 pm
@cara, That is very true, which is why delta hedges need to keep being changed (and this is stated in the lecture).
That is the reason for all the other Greeks, but you are only expected to know what they measure and you are not expected to be able to calculations with them.
October 20, 2012 at 7:23 pm
Sir..kindly let me know how he is going to gani by selling call option???if share price is falling…value of call option also falling…..he would have purchased call option at higher price….and by selling it at lower price it wont be loss???
October 21, 2012 at 6:50 am
@syedwaqar, You sell it first (at the higher price) and buy back later (at the lower price)
September 18, 2011 at 2:21 pm
Thank you .There is no way i would have learnt the delta hedge if i had not watched the video here
June 5, 2011 at 2:02 am
Question 3 in the Dec 2010 P4 examination paper is a good question on options.
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