The Greeks Flashcards
what is dynamic hedging
Dynamic hedging involves taking offsetting positions so that the asset and hedge move similarly with small market changes. It requires continual adjustments as market conditions change.
What key sensitivities must a risk manager of an option portfolio address?
A risk manager must assess how option prices change for:
1. A 1% change in stock price (Delta)
2. A 1% change in volatility (Vega)
3. The effect of time to maturity on portfolio gains/losses (Theta)
What is Delta in options trading?
Delta measures the sensitivity of an option’s price to changes in the underlying asset’s price (S). It is the first derivative of the option price with respect to S.
How does Delta differ for calls and puts?
Back:
- Delta is positive for call options.
- Delta is negative for put options.
What are the key properties of Delta?
Close to 0 for deep out-of-the-money (OTM) options.
* For call options, Delta is always less than +1.
* For put options, Delta is always greater than -1.
What is Delta Hedging?
Delta hedging offsets risk by taking positions in the underlying asset. For a short option position, buy Δ units of the underlying. The hedge must be frequently rebalanced.
What is Gamma in options trading?
Gamma measures how Delta changes with respect to the underlying price (S). It indicates the curvature in the price relationship.
What are the key properties of Gamma?.
- Generally positive (both call and put Delta increase when S increases).
- Largest for at-the-money (ATM) options.
- Smallest for deep ITM or OTM options.
- Decreases toward expiry (except ATM options).
What is Theta in options trading?
Theta measures the change in an option’s price due to the passage of time. It represents time decay and is generally negative.
How does Theta behave as maturity approaches?
Theta is largest (in absolute value) for ATM options.
* Theta’s absolute value decreases as maturity approaches (except for ATM options).
What is Vega in options trading?
Vega measures the sensitivity of an option’s price to changes in implied volatility.
What are the key properties of Vega?
- Always positive (higher volatility increases option value).
- Largest for ATM options.
- Decreases as expiry approaches.
What is Rho in options trading?
Rho measures the sensitivity of an option’s price to changes in interest rates.
How do interest rates impact call and put options?
- Higher interest rates increase call option prices.
- Higher interest rates decrease put option prices.
