Greek Letters

Question 0

Theta

Answer 0

Rate of change of the value of the option with respect to the PASSAGE OF TIME.

Usually negative.

Not used for hedging because the PASSAGE OF TIME is predictable.

Question 1

Delta

Answer 1

Rate of change of the value of the option with respect to the PRICE OF THE UNDERLYING ASSET.

Call options = positive
Put options = negative

Question 2

Gamma

Answer 2

Rate of change of the delta of the option with respect to the PRICE OF THE UNDERLYING ASSET.

Large gamma -> delta changes quickly -> delta neutral portfolios need to be rebalanced frequently to be kept delta neutral.

Small gamma -> delta changes slowly -> delta neutral portfolios do not need to be rebalanced frequently to be kept delta neutral.

A portfolio can be made gamma neutral.

Question 3

Vega

Answer 3

Rate of change of the value of the option with respect to the VOLATILITY OF THE UNDERLYING ASSET.

High vega -> sensitive to changes in the volatility of the underlying asset.

A portfolio can be made vega neutral.

Question 4

Rho

Answer 4

Rate of change of the value of the option with respect to the INTEREST RATE.

Question 5

Delta Neutral Portfolio

Answer 5

1. Option position + position on the underlying asset.
2. Value of the portfolio is not sensitive to small changes of the price the underlying asset.
3. Needs to be rebalanced when delta changes.