Individual Hedging Project

Choosing the strike price closest to being at the money on day one, noting the option price and using the following function in Matlab: [Call, Put] = blsprice (Price, Strike, Rate, Time, Volatility, Yield) The function was populated and volatility adjusted until correct call option price resulted. Knowing the correct volatility I used another function to calculate the delta value: [CallDelta, PutDelta] = blsdelta (Price, Strike, Rate, Time, Volatility, Yield) Having arrived at our delta value I multiplied this delta value by 100, as I am long 100 options, and by 100 again as it is implied that there are 100 shares per single option. This gives the total amount of shares that need to sell short to initiate a risk neutral position. Volatility and delta calculation were computed every day (per above) and amount of shares required adjusted i.e. if the stock price increased after day one then an increased number of shares would be sold to become risk neutral again.

Findings While a risk neutral position was adopted each day, a loss of 10,586.50 was recorded (Refer Figure 1 below). This is due to a loss suffered on options along with a loss on the underlying share transactions; intention initially was for any increase/decrease in share price, a corresponding decrease/increase to be noted in value of options. The factors affecting the price of options are; stock price, strike price, time to maturity, volatility, risk free rate and dividends. Of these the strike price and risk free rate remained constant, dividends were not applicable and time movements negligible leaving stock price and volatility. Figure 2 highlights how these two variables have moved. Day two has seen a 2.28% increase in share price but a 43% decline in volatility. Option price has dropped by 33% telling me the increase in share price has partly offset the decline in volatility (which is the key driver of option prices). Share price and volatility dropped on day three further reducing option prices with these being recouped on day four in addition to a gain on option price as volatility increased by more than previous days decrease. In conclusion, the losses suffered are due to a sharp decline in volatility in day two which did not recover for the duration of the remaining four days.

Figure 1
Day 1 1 2 3 4 5 Name Adobe Option Price Adobe Stock Price Adobe Stock Price Adobe Stock Price Adobe Stock Price Adobe Stock Price Price Multiplier for options 2.04 100.00 27.58 1.00 28.21 1.00 27.71 1.00 28.20 1.00 28.14 1.00 Trade Amt Current Price P&L 100.00 1.25 - 7,900.00 - 5,110.00 28.14 - 2,861.60 - 386.00 28.14 27.02 300.00 28.14 129.00 - 318.00 28.14 19.08 - 107.00 28.14 Profit/loss -10,586.50

Figure 2
Day Volatility % Change Volatility Share Price % Change Share Price Option Price % Change in Option Value 1 70.50% n/a 27.58 n/a 2.04 n/a 2 40% -43% 28.21 2.28% 1.37 -33% 3 38% -1% 27.71 -1.77% 1.03 -25% 4 42.50% 12% 28.2 1.77% 1.17 14% 5 38% -12% 28.14 -0.21% 1.25 7%