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Hello sir,
I saw the lecture on delta hedge and just want to know whether I’ve understood it right
(1) Suppose Nd1=0.5, Shares held = 100, So we will sell 200 call options
Now if the share price increase by $5, Profit from shares= 500
Call price will increase by $2.5, we will buy them to close the position and so loss= 2.5*200=500.. So overall no gain/loss… Have I understood it right??(2) Why would I close out the position ( buy call options later) if I’m making a profit from shares?? It only makes sense to do that if the share price falls right??
Kindly clarify sir..
Thanks a lotOne more question. (Related to real options)
(3) Option to switch/ redeploy would be a call or a put option? I’ve not seen it in past papers anywhere so wondered which option would it be if it comes in the paper..I guess I found the answer for (2).. Is it because the holder of call option would exercise the option as the share price increases and so we need to close the position by buying call options?
1. Correct.
2. As I do explain in the lectures, in practice it is the option dealers who are concerned about delta hedging and effectively they use it backwards. They need to cover themselves against them losing money on the options (because the purchaser has exercised them) and so they buy the relevant number of shares (using the delta hedge ‘formula’) so as to cover themselves against any loss.
What about (3) Option to switch/ redeploy?? A call or a put option and why?
Thanks a lot sir for (1) and (2)I don’t understand your question because there is no option to switch/redeploy mentioned.
“Options to switch/redeploy
It may be possible to switch the use of assets should market conditions change. A new plant could be designed with resale and/or other uses in mind, using more general-purpose assets than dedicated to allow easier switching”.
It is in the Kaplan text so was wondering whether it is a call/put option if it comes in the paper. Thank youI would be a put option (see Chapter 14 of our free lectures notes and the lecture working through the chapter).
I saw the notes but didn’t find a numerical example of option to switch/ deploy
I know that for an option to Abandon, Pe= Salvage value of asset when we are exercising the option and Pa would be cash flows foregoneI have 2 questions
(1) I still don’t get the reason WHY option to switch/redeploy would be a put option?(We are not selling the assets right?, we are just switching the use of it, then why a put option)
(2) What would Pa and Pe be in an option to switch/ redeploy ??Kindly answer these questions. Thanks a lot
1. Redeploying is like abandoning except that instead of receiving the proceeds of the sale of the assets they are getting the future benefits from whatever they switch to.
2. Computations of the value of options to switch/redeploy cannot be asked in the exam.
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