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.
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Hi John,
Why is it in this question we are Buying the Put options for the delta hedge?
Usually if its a call option we sell now and buy later for a delta hedge and should be the same case for a put, sell now and buy later so we can hedge a drop in the price of shares.
Please clarify.
Kind Regards,
To hedge against fall in the share price, you can either sell call options (and buy back later) or buy put options. Here the questions specifically asks you to use put options.
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Ok with a call we sell now at a high and buy back later at a low to hedge against a drop in share price.
But with a put, we buy put options at a high and sell later at low wouldn’t that make a loss if share prices drop?
Kind Regards,
Your first sentence is correct.
However if we buy a put option then that is it. If the price drops below the exercise price then we exercise the option and sell the shares at the exercise price. If the price does not drop below the exercise price then we simply do not exercise the option.
Buying a put option is actually more sensible if you own shares that you intend to sell in the future and are worried that the price will fall.
A delta hedge is (as I explain in the lecture) more relevant for option dealers who buy shares in order to hedge the risk they have on the options they have sold.
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Ahh sorry John,
I phrased the question wrong, i didn’t mean to say put option but a DELTA put option like that done in this particular question.
So they worked out the delta like we usually do in the case of a delta call but in this case its not a call its a put which the answer said we have to buy.
Why is it that we are buying delta puts? are delta puts the same as put options?
There is no such thing as a ‘delta put option’ (or a ‘delta call option’ for that matter).
We are taking about normal put (or call) options, and the only relevance of ‘delta’ is deciding how many options to trade in. The price of the options will change by delta (Nd1) multiplied by the change in the price of the shares, so we can use that to determine how many options to deal in.
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