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April 26, 2018 at 5:48 pm
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
John Moffat says
April 26, 2018 at 6:14 pm
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 🙂
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.
April 27, 2018 at 10:14 am
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
April 27, 2018 at 4:23 pm
That is correct – in the exam this is relevant for discussions, but for calculations we effectively assume they are American style options.
February 17, 2018 at 11:20 am
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?
February 17, 2018 at 12:06 pm
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.
February 18, 2018 at 11:35 am
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?
February 18, 2018 at 11:48 am
No. With a delta hedge you are selling call options that you do not have, and therefore you must buy them back.
February 18, 2018 at 4:49 pm
Ok Thank you very much.
February 19, 2018 at 5:07 am
You are welcome 🙂
January 13, 2018 at 9:34 pm
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?)
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?
January 14, 2018 at 10:11 am
No. The option price cannot be negative. It becomes worthless and the price would be zero.
January 14, 2018 at 5:34 pm
Thanks john, apart from that say it had not gone negative, would my calculations be correct?
January 15, 2018 at 5:44 am
Yes they would 🙂
January 8, 2018 at 9:01 pm
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
January 9, 2018 at 9:15 am
Using options is in itself hedging against movements in the share price. You wouldn’t then hedge against the options 🙂
September 26, 2017 at 11:00 am
Sir, I’m very confuse. Please kindly help to clarify.
1) Martin owns 1,000 shares. Are they the ones having the current price of $1.50? 2) Then, to safeguard himself, he bought call options from dealers? Or does he create call options himself? If he bought from dealer, should he only buy 1,000 options to safeguard against his 1,000 shares? And if so, how come he could have 4,080 call options to sell out?
September 26, 2017 at 2:09 pm
1. Yes – they are the only shares mentioned in the question 🙂
2. He will sell options now (and buy back later). It is perfectly possible on the stock exchange to sell things that you do not have, but of course you have to buy them back later. He will sell 4,080 now because he is creating a delta hedge and the change in the share price of 1,000 shares will equal the change in the option price of 4,080 options.
(Have you also watched part 1 of the lecture?)
September 27, 2017 at 2:35 am
Thank you so much for your clarification!
Yes, I already watched part 1 of the lecture. I never have experience dealing with share purchase/sale, so it’s quite difficult for me to imagine what happens there.
I now understand this. But just a few more questions – when you said “He will sell options now (and buy back later)”…
1) He sells to who? Will there be real cash transferred from buyer to him? 2) He is obligated to buy all options back right (4,080) right? Meaning, he cannot buy less than 4,080, correct?
Thank you in advance 🙂
September 27, 2017 at 7:46 am
Options are dealt on the stock exchange in the same way as shares – there are dealers who buy from some investors and sell to others.
Yes – he is obligated to buy all the options.
September 6, 2017 at 8:21 pm
When you said “Value of Options” did you mean the premium payable? or do options have a separate price to pay?
September 7, 2017 at 7:07 am
The premium payable – that is the cost of buying the option.
September 7, 2017 at 12:47 pm
Then what does BSOP actually give us? Isnt result of BSOP the premium payable?
September 7, 2017 at 1:36 pm
Yes – of course. What you have to pay to buy the option is whatever the value of the option is (which is what is given by the Black Scholes formula).
August 23, 2017 at 11:51 am
dear sir john ,according to what u have written beneath it means that if put options are used for delta hedging then they will be purchased as decrease in price will result in increase in put value and because of this we do not have to sell first and then buy as in the call options . (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)
August 23, 2017 at 3:34 pm
Yes – what you have written is correct.
August 23, 2017 at 5:14 pm
thank you sir ! u r such a dedicated person as u reply and help ! May God bless u . amen.
August 24, 2017 at 6:14 am
July 25, 2017 at 7:46 pm
Hello Sir. Please what about using the blackscholes model in equity valuation. You didnt ellaborate on it. or isnt it examinable?
July 26, 2017 at 7:20 am
It is examinable, but very rarely. I concentrate on share option pricing and on real options.
October 30, 2016 at 8:52 am
does delta hedge applies for put options holders or it is only for call option holders?Thank you
October 30, 2016 at 9:45 am
It can be relevant for put options (and I have answered you in the Ask the Tutor Forum).
June 20, 2016 at 9:53 am
What Martin will do if the share price increases? He owns only 1000 shares, but to make delta hedge he sells 4080 call options.
Let’s imagine that share price increased till $2. Profit on share price appreciation: (2-1.50)*1000 = 500 Profit on call options sale: 0.04*4080 = 163.20 Total: 663.20
The profit isn’t enough to provide 4080 shares
June 20, 2016 at 3:10 pm
I don’t know where you got 0.04 from.
If the share price increases by $0.50, the option price will increase by N(D1) x $0.50, which is 0.2451 x $0.50 = $0.12255. 4,080 options x $0.12255 = $500
May 25, 2016 at 4:38 pm
@JohnMoffat kindly clarify for me;if the how delta heding reduce conflict between shareholders and bondholders?
May 25, 2016 at 5:38 pm
The purpose of a delta hedge is not to reduce conflict between shareholders and bondholders! If you read that somewhere then either you have misunderstood or the book is wrong 🙂
June 12, 2016 at 2:46 pm
Dear 1st i say to you thank you i pass my f9 with 60 marks totally study from opentution.i chose p4 because i am confidant as i have best teacher i can pass it
June 12, 2016 at 2:51 pm
Sir my q is about delta hedging as you say that when price of share fall call option price also fall so we will sale call option to compensate the loss againts profit but at which price we will sale the call option is this will be exercise price or at price which is goes down ? And call option period is 3 month can we exercise it before 3 month or on exact 3 month please sir explain
June 12, 2016 at 5:48 pm
Thank you for your comment, and congratulations on passing F9 🙂
We have to sell the call option at one current prices for one of the strike prices available. Which we choose is up to us.
For European style options we can only exercise in exactly 3 months time. For American style options we can exercise at any time up to 3 months. In the exam, although you need to know this for written questions, for calculation questions we will always treat them as though they are European style.
May 6, 2016 at 9:35 am
Am I correct in understanding that the only reason the dealer would buy the shares is because he would not have any shares to sell should the option buyer exercise his right?
In which case, how does the dealer make money? Surely the gains on the option and loss on the sahres will net themsleves out if the price goes down. But if they go up, he will have lost money on the option but also on the shares he will have sold at the exercise price instead of the market value?
Thank you for your clarification
May 6, 2016 at 2:34 pm
By creating a delta hedge, the dealer protects him/herself against having to pay out on the options because there will be an increase in the share price to compensate. And, of course, the dealer has also received a premium for the options.
May 4, 2016 at 2:53 pm
in ex6 If the share price falls by $1 then the call option would fall by 25c. But if we take the figures from ex5 the call option was 5c. I know it sounds rediculous to sell call options at -20c (5-25). Im not seeing something here. Could you please enlighten me?
May 4, 2016 at 5:21 pm
The current price of the option would still be 25c.
However the option was the right to buy shares at $1.80. If the actual share price at the exercise date were less than $1.80 then you would not exercise the option – it would be cheaper to buy the shares directly.
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?
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.)
August 23, 2017 at 10:19 am
oh thank your sir ! that was brilliant ! i was confused here that from whose point of view but u cleared it .
November 22, 2017 at 3:22 pm
Thanks John. i also wasn’t sure whose point of view you were talking about all this time until now
November 22, 2017 at 3:34 pm
May 19, 2015 at 9:39 am
Hi Sir, 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
Dear sir, 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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