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Copyright © 2000-2006
Investment Analytics
1
Agenda
Option sensitivity factors
Delta
Delta hedging
Option time value
Gamma and leverage
Volatility sensitivity
Gamma and Vega hedging
money money 1
0 0.5
X Stock Price
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IBM Option Delta
Option
Finishing in-
the-money
S X.e-rt
Out-of-the-Money
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Delta: At-the-Money
Probability
S = X.e-rt
At-the-Money
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Delta: In-The-Money
Delta 1
Probability
X.e-rt S
In-the-Money
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Delta: Conclusions
Delta “measures probability of finishing in the
money”
A deep out-of-the money option has a low delta
An at-the-money has a delta of around 0.5 as it
approaches expiry
i.e. a 50-50 chance of ending up in the money
As an option moves deep into the money, its
delta rapidly approaches 1
Gamma measures rate of change of Delta
Expiration
Stock price
Strike Price
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Time Decay (Theta)
Decay Acceleration
Premium
0
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Time Value of IBM Option
Vega Theta
Standard Deviation
X i = Ln( Pi +1 / Pi )
σ= ∑ ( X i − X ) 2 / ( N − 1)
Option Greeks
Measures of option sensitivity
Delta hedging
Gamma & Vega hedging