Share Options and Option Pricing part 2
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Dear John ,
If the price is falling then why are we not buying Pull options as it will deal with the downside risk of price falling rather than hedging . and it is not like the Hedging will compensate or exactly offset the loss of falling share price. Then why are we using Delta Hedging and besides that, the European option can only be exercised at future date,, so how can we sell it now and buy back later,,, i dont understand this plzz explain this
You could certainly use put options – however usually the exam questions expect you to use call options.
As I explain the lecture, in practice it is option dealers who use delta hedging, which is why it is usually the way it is. However for the exam you do what you are told 馃檪
Options are traded on the stock exchange, so with European style options you can buy today (at whatever todays price is) and sell later (at whatever the later price is) – or obviously the other way round. They are traded on the stock exchange just like shares are traded – you can buy shares at todays price and sell later at the later price.
thank you so much for your prompt responses John,,
So on expiration date if we bought earlier we sell option and vice versa which allows to net off the risk ,, am i right John,,, if i am wrong please correct me
That is correct – in the exam this is relevant for discussions, but for calculations we effectively assume they are American style options.
Hello Sir,
Thanks for the lecture. My question is if you sell call option and the value of the shares is falling, then it’s likely that those who bought the call option won’t exercise it. So why do you have to buy them back rather than leave it and don’t buy to make more profit since the buyers won’t exercise it anyway?
The options are traded and so you sell at todays price and then buy at whatever the price is later. Nobody is exercising them at that stage. The options will still have a price on the stock exchange, but the price will have fallen.
But please can you then decide to wait till expiry when it will expired without you paying anything to buy them back since the value of the underlining share has reduced and therefore it will not be exercised?
No. With a delta hedge you are selling call options that you do not have, and therefore you must buy them back.
Ok
Thank you very much.
You are welcome 馃檪
Please confirm if I have this correct:
Say the price of the share fell by 50c
Change in option = Change in Share x 0.2451 = 50c x .2451 = 12.25c
So the price of the option changes from 5c (as per ex 5) to (-7.25c) (can you have a negative option price?)
Summary
Sell now 5c x 4080 options = $204
Buy later -7.25c x 4080 options = -$296 (they give you $296)
Profit of $500
Current Sh Price = 1.50
New Sh Price = 1.00
Loss of shares = 0.5×1000 = $500
the hedge means no gain / no loss?
No. The option price cannot be negative. It becomes worthless and the price would be zero.
Thanks john, apart from that say it had not gone negative, would my calculations be correct?
Yes they would 馃檪
Dear Sir
What if you sell a call option option first with the belief that the price would fall in the nearest future to buy it back, but the price went up further rather than coming down
How can one hedge against that
Using options is in itself hedging against movements in the share price.
You wouldn’t then hedge against the options 馃檪