Derivatives: Greeks and Black-Scholes

1. Determine which parameter is not present in the Black-Scholes formula

(A) interest rate, r

(B) time-to-maturity, T − t
(C) volatility, σ
(D) drift, µ.
Analogous to the absence of p from the price in the binomial tree case, the
drift term µ is absent from the pricing formula

2. The delta of a call option is the same as the delta of a put.

(A) TRUE
(B) FALSE
By put-call parity:
∆call = ∆put + 1

3. As the current price of the underlying moves away from the strike (in either
direction) the delta of a call option approaches 1.

(A) TRUE
(B) FALSE
As the current price of the underlying moves away from the strike, then
the delta of an option approaches 0 or 1 (in absolute value).

4. Consider 2 call options with same strike but different time to maturity: 0.5
years and 2 weeks. The delta of the call option with 2 weeks to maturity goes
to zero or one faster than the delta of the option with 6 months to maturity.

(A) TRUE
The delta goes to zero or one faster for small time-to-maturity. E.g. with
only 2-and-half weeks to maturity there is not much chance for the under-
lying to either get into the money if it is down below (the strike) or to fall
out of the money if it is up high (the strike). Therefore the delta quickly
goes to one or zero depending on whether the stock price is above or below
the strike
(B) FALSE

1
5. The delta of an in-the-money option increases toward 1 as the time to maturity
goes toward zero.

(A) TRUE
If the option is ITM, delta increases toward one as the time to maturity
goes toward zero. Intuition: as the time to maturity goes to zero it becomes
more likely to exercise the option.
(B) FALSE

6. The Gamma of a put is the same as the gamma of a call. True or false?
True: Γcall = Γput by put-call parity

7. When compared to longer maturity options, the gamma for shorter maturity
options is is steeper around the strike and it falls away to zero much faster.
True or false?
True: Gamma is steeper (around the strike) for shorter maturity option and it
falls away to zero much faster than for longer maturity options.

8. The Γ of ITM or OTM options falls toward zero as the time to maturity ap-
proaches zero. True or false?
True. Intuition: as the time to maturity approaches zero we know for sure we
are (not) going to exercise if we are ITM (OTM).

2
 9. As the underlying stock price moves, the delta of a position changes. In order
to remain delta-neutral, it is necessary to revise the position over time. Assume
you are long a call option and you want to delta-hedge. According to ”gamma”,
when the stock goes down, delta-hedging prescribes an additional

(A) purchase of stock shares

True: When the stock price goes down, delta alone predicts too much of
a decrease in the option price, and we have to add something to correct
the prediction. (remember we are short stock to delta-hedge; as the stock
price goes down, we reduce our short position by purchasing stock shares)
(B) sale of stock shares

10. The ”Vega” of an option goes to zero as the stock price moves away from the
strike.True or false?
True. Intuition: approximation of B-S value formula.

11. When there is just one day to maturity the ”theta” of an ATM option is more
negative because you have more to loose over the next day than you would if
there was one-year to maturity.True or false?
True.

3
12. Assume that S = $40, σ = 30%, r = 8%, and δ = 0 (non-dividend paying stock).
Suppose you sell a 45-strike call with 91 days to expiration. Also assume the
option is on 100 shares. What investment is required for a delta-hedged portfolio
(equivalently, what is the total value of your delta-hedged position)? (please
report your answer with 1 decimal; also, for this question, you can use the BS
option pricing function provided in excel)
The delta of the option is 0.2815.
To delta hedge writing 100 options, we must purchase 28.15 shares for a delta
hedge.
The total value of this position is 1028.9=40×28.15−97.10, which is the amount
we will initially borrow.

13. Assume that S = $40, σ = 30%, r = 8%, and δ = 0 (non-dividend paying

stock).Suppose you sell a 40-strike put with 91 days to expiration. Also, assume
the option is on 100 shares and you form a delta-hedged portfolio. What is your
overnight profit if the stock price tomorrow is $39 (assuming you fully borrow to
establish the position)? (please report your answer with 2 decimal places; also,
for this question, you can use the BS option pricing function provided in excel)
Using the BS formula we can solve for the put premium and the put’s delta:
P = 1.9905
and ∆ = −0.4176. If we write this option, we will have a position that moves
with the stock price. This implies our delta hedge will require shorting 41.76
shares (receiving 41.76 × 40 = 1670.4).
We must look at the three components of the profit. There will now be interest
earned since we are receiving both the option premium 199.05 as well as the


1670.40 on the short sale. The $1869.43 will earn 1869.43× e0.08/365 − 1 = 0.41
in interest.
If the stock falls to 39 we make 41.76 on our short sale.
If the stock prices falls to 39, the price of the put option we wrote will be (using
T = 90/365)
P (@39) = 2.4331
This implies our option position will lose 243.31 − 199.05 = 44.26 if the stock
falls by $1.
Combining these results, our profit will be
41.76 − 44.26 + 0.41 = −2.09
if the stock price falls to $39

4
14. If the stock moves according to the binomial model, the delta-hedge portfolio is
approximately self-financing (i.e., you would breaks even in terms of profit).True
or false?
True.

5
15. Assume that S = $40, σ = 30%, r = 8%, and δ = 0 (non-dividend paying
stock). Consider a call option with strike K=40$. The Delta and Gamma of
the option are given by, respectively, 0.5824 and 0.0652. Assume the stock price
declines to $39.25. What would be the call value predicted by the Delta-Gamma
approximation? (please report your answer with 3 decimal)
For a stock price decline to $39.25, the true option price is $2.3622. The D-G
approximation gives $2.3619=C(40)+0.75×0.5824+0.5×0.752 ×0.0652, where
C($40) = 2.7804.

16. Consider a market maker that has sold a call option. Which of the following are
viable strategies that protect against extreme price moves? (there may be more
than one correct answer)

(A) Implement delta-hedging

This is false since delta-hedging is short Γ.
(B) Adopt a Gamma neutral position by using stocks to hedge
False. A stock has Γ = 0 so you cannot use stocks to implement gamma-
neutral positions.
(C) Buy a put with the same strike price and maturity as the written call, and
then buy 100 shares (assuming the option is on 100 shares)
True: this is put-call parity.
(D) Enter into a variance swap to receive payment from the counterparty if the
stock makes a large move in either direction.
True: to hedge a negative-gamma, delta-neutral position, the market-
maker would make a payment to a counterparty if the stock makes a small
move in either direction, and receive payment from the counterparty if the
stock makes a large move in either direction. This is effectively a variance
swap

6
17. Assume you have two European call options (same maturity and same under-
lying), Call-A and Call-B, on a stock. Call-A has a Delta=0.5825. Call B
has a Delta=0.7773. You sold 1000 units of Call-A, buy 872.7 units of Call-B
and sold 95.8 shares of the underlying stock. What is the delta of your overall
position?
∆portfolio = −$1000 × 0.0651 − 95.8 × 1 + 872.7 × 0.0746 ≈= 0

18. Option positions in the aggregate sum to zero.

True. This is important! The market-making community as a whole can buy
protective options only if investors in the aggregate are willing to sell them.
Investors, however, are usually thought to be insurance buyers rather than
insurance sellers. So augment the market maker portfolio by buying deep-out-
of-the-money puts and calls is not a viable strategy.