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CH 18 Hull OFOD8 TH Edition
CH 18 Hull OFOD8 TH Edition
+ A + A + A + A =
+ A
c
H c
+ A
c
H c
+ A
c
H c
+ A
c
H c
= AH
2
2
2
2
2
1
2
1
S t S
S
S
t
t
S
S
Gamma Theta Vega Delta o
o
o
Managing Delta, Gamma, &
Vega
Delta can be changed by taking a position in
the underlying asset
To adjust gamma and vega it is necessary to
take a position in an option or other derivative
Options, Futures, and Other Derivatives, 8th Edition,
Copyright John C. Hull 2012
22
Example
Options, Futures, and Other Derivatives, 8th Edition,
Copyright John C. Hull 2012 23
Delta Gamma Vega
Portfolio 0 5000 8000
Option 1 0.6 0.5 2.0
Option 2 0.5 0.8 1.2
What position in option 1 and the underlying asset will
make the portfolio delta and gamma neutral? Answer:
Long 10,000 options, short 6000 of the asset
What position in option 1 and the underlying asset will
make the portfolio delta and vega neutral? Answer: Long
4000 options, short 2400 of the asset
Example continued
Options, Futures, and Other Derivatives, 8th Edition,
Copyright John C. Hull 2012 24
Delta Gamma Vega
Portfolio 0 5000 8000
Option 1 0.6 0.5 2.0
Option 2 0.5 0.8 1.2
What position in option 1, option 2, and the asset will make the
portfolio delta, gamma, and vega neutral?
We solve
5000+0.5w
1
+0.8w
2
=0
8000+2.0w
1
+1.2w
2
=0
to get w
1
= 400 and w
2
= 6000. We require long positions of 400 and
6000 in option 1 and option 2. A short position of 3240 in the asset
is then required to make the portfolio delta neutral
Rho
Rho is the rate of change of the value
of a derivative with respect to the
interest rate
Options, Futures, and Other Derivatives, 8th Edition,
Copyright John C. Hull 2012
25
Hedging in Practice
Traders usually ensure that their portfolios
are delta-neutral at least once a day
Whenever the opportunity arises, they
improve gamma and vega
There are economies of scale
As portfolio becomes larger hedging becomes less
expensive per option in the portfolio
Options, Futures, and Other Derivatives, 8th Edition,
Copyright John C. Hull 2012
26
Scenario Analysis
A scenario analysis involves testing the effect
on the value of a portfolio of different
assumptions concerning asset prices and
their volatilities
Options, Futures, and Other Derivatives, 8th Edition,
Copyright John C. Hull 2012
27
Greek Letters for European Options on
an Asset that Provides a Yield at Rate q
Options, Futures, and Other Derivatives, 8th Edition,
Copyright John C. Hull 2012
28
Greek Letter Call Option Put Option
Delta
Gamma
Theta
Vega
Rho
) (
1
d N e
qT
T S
e d N
qT
o
0
1
) (
'
T S
e d N
qT
o
0
1
) (
'
| | 1 ) (
1
d N e
qT
( )
) ( ) (
2 ) (
2 1 0
1 0
d N rKe e d N qS
T e d N S
rT qT
qT
+
' o ( )
) ( ) (
2 ) (
2 1 0
1 0
d N rKe e d N qS
T e d N S
rT qT
qT
+ +
'
o
qT
e d N T S
' ) (
1 0
qT
e d N T S
' ) (
1 0
) (
2
d N KTe
rT
) (
2
d N KTe
rT