Delta hedging

[charlesyy]

Hi

1. The increase in volatility makes both call and put more valuable. The increase in value is a loss to the dealer’s short option position ans is not offset by immediate change in value of the shares used for the hedge. There is an immediate loss on the net hedged position.

Why immediate loss?

2. Why is time premium the largest for ATM options and it diminishes as the option moves OTM or ITM?

Thank you

[S2000magician]

@charlesyy

Hi

Howdy!

@charlesyy

1. The increase in volatility makes both call and put more valuable. The increase in value is a loss to the dealer’s short option position ans is not offset by immediate change in value of the shares used for the hedge. There is an immediate loss on the net hedged position.

Why immediate loss?

Because the options have lost value and the stock has not.

@charlesyy

2. Why is time premium the largest for ATM options and it diminishes as the option moves OTM or ITM?

Thank you

Draw a picture of the intrinsic value of an option and the price (premium) for the option. The (vertical) difference between the two is greatest at the money.

If you want the mathematical justification for that, you’ll have to delve into an options pricing model, such as Black-Scholes-Merton.