Question

1.Explain how an increase in implied vol would change your delta hedging position if the SAC option was In-The-Money, assuming you wanted to maintain a delta neutral position.

2.Explain how theta erosion affects your delta hedging position as the option approaches maturity if the SAC option is In-The-Money, assuming you wanted to maintain a delta neutral exposure.

3.If your boss told you to reduce the volatility of the portfolio's value as close to zero as possible, what trading strategy would you implement? Why?

Answer 1

1.

Long put options always have a delta ranging from -1 to 0, while long calls always have a delta ranging from 0 to 1. The underlying asset, typically a stock position, always has a delta of 1 if the position is a long position and -1 if the position is a short position. Given the underlying asset position, a trader or investor can use a combination of long and short calls and puts to make a portfolio's effective delta 0.

Relationship of Volatility and Delta for ITM option

• Lower volatility results in higher Delta
• Higher volatility results in lower Delta

2.

Theta erosion is the time decay of an option. As maturity of the option approached the theta decay increases and will affect all the OTM options to '0'.

3.

There are many ways to reduce the volatility of a portfolio. However the best and easiest one is to choose the stocks of a portfolio in such a way so that Beta of the portfolio remains closest to 1(closest to index). One way to do is to choose mainly the Index stocks or the large cap stocks in the portfolio .

Then one should right or sell equal value of Call Of the options of the Index. Or in other words Covered call strategy for Index.

If the market falls.. the loss(MTM Loss) in the portfolio will be compensated by the Income in the option writing

If the market rises the loss in the option position will be compensated by the increase in the portfolio stocks (MTM profit).

Thus the portfolio will be low in volatility from the market.