This question focuses on the risk management of European vanilla options, and re

Question

This question focuses on the risk management of European vanilla options, and refers to the data in the following table: Delta Gamma Vega Portfolio -450 -6,000 -4,000 Option (1) 0.6 1.5 0.8 Option (2) 0.1 0.5 0.6 The portfolio consists of several traded European vanilla options. Option 1 and Option 2 are two other traded European vanilla options available to hedge the portfolio. (i) What position in Option 1, Option 2 AND the Underlier would make the portfolio delta, gamma and vega neutral? (ii) What are the limitations of this hedge?

Explanation / Answer

Ans:

Step-1:

Delta Gamma Vega portfolio: Option 1

= -450 * 0.6 = 270

= -6,000 * 1.5 = 9,000

= -4,000 * 0.8 = 3,200

Option-2:

-450 * 0.1 = 45

-6,000 * 0.5 = 3,000

-4,000 * 0.6 = 2,400

Step -2:

Delta hedging is a strategy used to mitigate the risk associated with the price move in the underlying asset of an option by entering an offsetting position. Although this hedge reduces a portfolio's exposure to the underlying asset, it has its limitations. One limitation of delta hedging is that a position still has risk exposure even if the position is delta-neutral. Delta hedging needs to be constantly readjusted with movements of the underlying asset.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.