Option Risks

Uploaded by HedgeFundGroup on 25.09.2011

bjbj Option Risks In this short video, we will discuss options risk. We will define
each risk and how this affects a portfolio of options along with a brief description
of how to hedge these types of risks. The risks that will be discussed are The Delta
The Gamma The Vega The Theta correlation risk within options and strike map risk. The Delta
is the theoretical directional exposure an investor has to an underlying asset. Delta
is generally measured in percentage terms which is then converted into shares or contracts.
For example, the delta of an after money call option is approximately 50% on one options
contract which is 100 shares. The theoretical exposure to any movement in the underlying
market is 50 shares. A $1 move in either direction leaving all other factors unchanged would
create a penal of $50 or minus $50. The delta of an option moves to one as a call goes deep
in the money. It moves to zero as a call goes deep out of the money. When trading options
the delta is usually the largest and most sensitive risk. For portfolio manager and
risk managers, tracking directional risk, the delta is generally the most important
factor. To hedge the delta of an option, an investor can either initiate an offsetting
position in the underlying shares, contracts or use other options. For example, if an investor
purchased one option of an apple that was at the money, the investor could hedge the
delta by shorting 50 shares of apple stock. Gamma risk, deals with the second-order effect
for options. Gamma is the first derivative of the delta and is used when trying to gauge
the price of an option relative to the amount it is in or out of the money. Gamma not only
affects the price of an option but additionally the delta of the option, the higher the gamma
of the option, the greater the change in the delta relative to any underlying movement
in the price of underlying assets. Positive gamma risk generally is associated with long
options positions while negative gamma risk is associated with short options positions.
The second-order can quickly change giving definite strike prices of options within a
portfolio and as an important risk for portfolio managers to understand. In practical terms,
positive gamma will produce increases in delta as the market moves higher. So if you started
at, at the money and the market moved higher, the gamma would increase the number of shares
from 50 to 60. The same would occur if you had positive gamma on the downside. If you
started with 50 shares and the market moved lower, your gamma would decrease the number
of shares you had theoretically from a delta of 50 to a delta of 40. And investor receives
the benefit of gamma by purchasing options which requires an investor to pay premium
which also equals the value of an option. Investors can hedge their gamma by buying
and selling options. The next order of risk is volatility or vega risk. The volatility
or vega risk of a financial security is also known as implied volatility of a portfolio.
The vega of a portfolio is the change in the value of a portfolio due to the perceived
change and how much the financial instrument will move over the course of time. Implied
volatility is a measurement used in the pricing evaluation of options and it is generally
quoted in percentage terms. Vega is generally reported as a dollar figure for 1% move of
implied volatility. To hedge vega, investors need to use options to mitigate this risk.
Long option positions create positive vega while short options positions create negative
vega. Theta is the Greek term for time decay and represents risks relative to time. The
decay of time for a
long position is not linear and therefore time decay grows more quickly as an option approaches expiration. The theta
of a portfolio shows the amount of dollar gain or loss from one day of holding the securities
in a portfolio. Correlation risk comes from exotic
options such as spread options which have exposure of a portfolio to the correlation
of these options and are priced and valued using the relative correlation as an input
parameter. The options are sensitive to the change in the underlying correlation of one
security relative to another. This risk in embedded into the pricing of specific types
of options. The hedge -- to hedge this type of risk, an investor needs to buy or sell
similar types of options. Lastly, we will discuss strike risk or strike map risk which
is a measurement of the exposure to a specific prices across a portfolio. This concept allows
a trader to understand specific exposure as prices move up and down a price scale. Each
price might generate positive or negative delta, gamma and vega as the financial instrument
moves up and down the price scale. When risk limits are calculated in an option portfolio,
a risk manager needs to understand not only the current risks but what could occur if
the market moves to another strike price. For example, you might have in a specific
tenor bucket say, three months, a short call at $25 on a security and a long call at $20.
As the market moves higher in price away from the long call and to the short call, the positive
gamma and vega that is received will change to negative gamma and vega as the market continues
higher. The risk manager also needs to be aware of other tenor buckets which will create
positive and negative gamma. Along put, as the market goes a little slower will become
less and less positive gamma and negative -- positive gamma along put will become less
positive gamma and vega and more short gamma and vega as the market goes lower. Strike
map risk requires the risk manager to look at all the strikes within a portfolio to understand
the relative risks as the markets begin to move. PAGE \* MERGEFORMAT hNs[ gdFN gdFN phZZZ
[Content_Types].xml Iw}, $yi} _rels/.rels theme/theme/themeManager.xml sQ}# theme/theme/theme1.xml
w toc'v )I`n 3Vq%'#q :\TZaG L+M2 e\O* $*c? )6-r IqbJ#x ,AGm T[XF64 E)`# R>QD =(K& =al-
4vfa 0%M0 theme/theme/_rels/themeManager.xml.rels 6?$Q K(M&$R(.1 [Content_Types].xmlPK _rels/.relsPK
theme/theme/themeManager.xmlPK theme/theme/theme1.xmlPK theme/theme/_rels/themeManager.xml.relsPK
bg1="lt1" tx1="dk1" bg2="lt2" tx2="dk2" accent1="accent1" accent2="accent2" accent3="accent3" accent4="accent4"
accent5="accent5" accent6="accent6" hlink="hlink" folHlink="folHlink"/> H1k\s \`6c &;Yf 1k\s
Normal Debrahliz Reyes Microsoft Office Word Grizli777 Title StyleName="APA" xmlns:b="http://schemas.openxmlformats.org/officeDocument/2006/bibliography" xmlns="http://schemas.openxmlformats.org/officeDocument/2006/bibliography">
Microsoft Office Word 97-2003 Document MSWordDoc Word.Document.8