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at 19:20, you say option is out of the money, but in the example he sold the option, and the price went down, so he's in the money and that is why hedge ratio goes down when Spot price goes down to 195.
Hi. Great comment. However, in finance, we say "the option" is in the money and not "the investor" is in the money. Here is a quick clarification: For a call option, whenever the strike price (in our example, $202) is higher than the current market price (in our example, $200), the option is out of money. This is regardless of the position of the investor (whether he is long the call option or has a short position/has written the option). So in our example, the option is out of the money at $200, and further out of the money at $195. However, our investor stands to gain from the option being out of the money because he has a short position in the call option. In summary, the long position stands to gain from an option expiring in the money while the short position gains from the option expiring out of the money. I hope this helps. Let us know if it's still unclear.
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Hi. So we know that delta only looks at the tangent point on the curve. You can see a graphical representation here: image.slidesharecdn.com/gamma2corrected-150612131617-lva1-app6891/95/option-gamma-dynamic-delta-hedging-14-638.jpg?cb=1434115007 As time passes, there is a strong likelihood that the option will move away from our original tangent point. Therefore, our hedge will be imperfect, as represented by the blues area on the image. Delta hedge is pretty good in the short term and for options with low volatility. Also, it is less costly in terms of transaction costs. If we want to perfectly hedge something (such as a longer-term position or a more volatile position), we would use a delta-gamma hedge. However, there are more costly since they basically require us to buy and sell assets each day for the hedge to remain a perfect hedge.
Professor God bless you! This is exactly the exercise my prof gave me as assessment for my final grade.
Glad it helped!
thanks for the videos. Im from Ontario studying finance and they've been very helpful.
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at 19:20, you say option is out of the money, but in the example he sold the option, and the price went down, so he's in the money and that is why hedge ratio goes down when Spot price goes down to 195.
Hi. Great comment. However, in finance, we say "the option" is in the money and not "the investor" is in the money. Here is a quick clarification:
For a call option, whenever the strike price (in our example, $202) is higher than the current market price (in our example, $200), the option is out of money. This is regardless of the position of the investor (whether he is long the call option or has a short position/has written the option).
So in our example, the option is out of the money at $200, and further out of the money at $195. However, our investor stands to gain from the option being out of the money because he has a short position in the call option.
In summary, the long position stands to gain from an option expiring in the money while the short position gains from the option expiring out of the money.
I hope this helps. Let us know if it's still unclear.
@@analystprep Thanks for the clarification|!!
Your videos are the best for a review - The best!
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PASSED LEVEL 1!
THANK YOU DR. JAMES
Any planning ..pls guide
a very helpful journey with you professor!
Thank you
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Thank you very much Professor
23:51. the formula of theta put seems wrong. for the 2nd part, should be +rXe^(-rT)*N(-d2), right?
I've got a question, it is probably obvious but why the delta neutral hedge has to be short term? Why we hedge only with short term options?
Hi. So we know that delta only looks at the tangent point on the curve. You can see a graphical representation here: image.slidesharecdn.com/gamma2corrected-150612131617-lva1-app6891/95/option-gamma-dynamic-delta-hedging-14-638.jpg?cb=1434115007
As time passes, there is a strong likelihood that the option will move away from our original tangent point. Therefore, our hedge will be imperfect, as represented by the blues area on the image.
Delta hedge is pretty good in the short term and for options with low volatility. Also, it is less costly in terms of transaction costs.
If we want to perfectly hedge something (such as a longer-term position or a more volatile position), we would use a delta-gamma hedge. However, there are more costly since they basically require us to buy and sell assets each day for the hedge to remain a perfect hedge.
Awesome 👍👍👍
Thank you! Cheers!