By Jawwad Ahmed Farid
This ebook presents a hands-on, sensible advisor to knowing derivatives pricing. geared toward the fewer quantitative practitioner, it presents a balanced account of strategies, Greeks and hedging ideas keeping off the complex arithmetic inherent to many texts, and with a spotlight on modelling, industry perform and intuition.
Read or Download An Option Greeks Primer — Building Intuition with Delta Hedging and Monte Carlo Simulation Using Excel PDF
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Extra resources for An Option Greeks Primer — Building Intuition with Delta Hedging and Monte Carlo Simulation Using Excel
Example text
Term structure of volatility: A curve that shows the movement of implied volatilities against changing time to maturity. Terminal price: Price of the underlying security on the maturity of the option. Theta: Measures the change in the value of the option due to a change in the time to expiry or maturity. Time premium: Represents the change in the value of the option as the option approaches expiration. It is calculated as the difference between the value of the option at inception and its value at expiry.
What does that mean in simpler language? In the image above, the Gamma peak corresponds to at money options while the dips at the two ends correspond to deep out and deep in money options. com If you hedge your Delta but ignore your Gamma, your hedge may remain effective as long as prices do not move – but a large movement in the underlying will move Delta as well as your underlying exposure. For at money options the risk of large moves impacting Delta is higher (higher Gamma); for deep in and deep out of money options, the risk of large moves impacting Delta is lower.
Let’s also assume that the spot price of the underlying security (crude oil) for immediate delivery is US$90 per barrel. The price at which we can buy crude oil using our option is the strike price. In this specific case the strike price of the call option is significantly higher than the current spot price, hence the option is trading out of money. As a buyer to the option, you would not exercise the option, as it would not make economic sense to do so. If the spot price fell further – to US$80 per barrel for example – the option would be trading deep out of money.