100%(1)1 out of 1 people found this document helpful
This preview shows pages 1–4. Sign up to view the full content.
1The Greek Letters (Ch. 18)Management of Market RiskDelta Gamma VFINS 3635 week 121Vega Other Greek LettersTheta Rho Example (Hull 18.1)A bank has sold (for $300,000) a European call option on 100,000 shares of a non-dividend paying stockS0= 49, X= 50, r= 5%, = 20%, FINS 3635 week 122T =20 weeksThe Black-Scholes value of the option is $240,000How does the bank hedge its risk?In, at or out of the money?What risk does the bank face?Naked & Covered Positions (Hull 18.2)Naked positionTake no action-how much could the bank lose?Covered positionFINS 3635 week 123Buy 100,000 shares today- what is wrong with this strategy?Both strategies leave the bank exposed to significant risk. When does the bank ‘need’ the underlying?
This preview
has intentionally blurred sections.
Sign up to view the full version.
2Stop-Loss Strategy (Hull 18.3)Buy 100,000 shares as soon as price reaches $50Sell 100,000 shares as soon as price falls below $50FINS 3635 week 124This simple hedging strategy does not work well. Why not?1) transaction costs2) how do you decide whether the price will go up or down or will continue?3) Buy high and sell lowMore Sophisticated Hedging StrategiesTry to hedge option price riskHow?Look for the factors that have effects on the option priceFINS 3635 week 125Figure out relation between these factors and option priceMeasure how sensitive of the option price is to the changes in value of these factorsCome up a strategy to reduce the sensitivity, i.e., risk-free (risk neutral) portfolio Determinants of option pricesFive factors determine option prices:Price of the underlyingSExercise priceXVolatility of returns of SσFINS 3635 week 126time to maturity of optionT or (T-t)risk free raterWhat is the effect of a change of one of these factors on the option price holding all others constant?