To calculate the number of options used in a delta hedge, the general formula is delta = number options/number shares. In some cases, Schweser use 1/delta = number options/number shares.
Is there someone who can explain me when I have to use delta and when 1/delta?
Thanks in advance!
i believe something in wrong with your first formula
Number of shares = delta x number of options.
There are times when you use 1/delta:
If you have a $5million position in bonds, and want to hedge against loss, you should buy puts on the bond. This is a case where you multiply delta* (portfolio/contract size)
However, if you wanted to hedge using CALLS, you would have to sell the calls. In this case you would use 1/delta * (portfolio/contract size)
See Schweser exam book 2, mock 2, question 43 afternoon session
I’m pretty sure that multiplying by delta is incorrect here.
Oh no! do we always use 1/delta? thanks S2000 for your work on this forum
Yes.
My pleasure.
Basically it’s just this:
To hedge for 1% or 10 basis point.
Delta*Value of Option*#of option = Portfolio
Delta = change in option price/change in underlining. Change in underlining is it’s duration. So If delta =.3333 and duration is 3, option will only go up by 1 duration .
Is there no general rule when to use number stock = delta * number option and when number stocks = 1/delta * number options?
This is because option delta is
Number of call / number of stocks = 1 / delta …
to get number of stocks you multiply i guess… that’s what i can get this one.