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  1. 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?

    • 1. Yes – they are the only shares mentioned in the question 馃檪

      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?)

      • 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 馃檪

      • 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.

  3. 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)

  6. 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

    • 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

      • 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

      • 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

      • Thank you for your comment, and congratulations on passing F9 馃檪

        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.

  8. Hello

    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

    Thank you.

    • 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.

  9. 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?

    • 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.

  10. Hi Sir,

    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?

    • 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.

      • 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?

      • That is correct 馃檪

        (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.)

  11. 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.

    Thanks

  12. Hello Sir

    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.

    Many thanks

    • 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.)

  14. @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.

    • 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 馃檪 ). 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.

      • 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!

      • 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).

  17. Hello Sir,

    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.

    • @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.

  18. HELLO!!!

    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???

    Regards

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