Published August 28th, 2007
in Black Scholes.
For those who do not know, the delta is the sensitivity of an option to a movement of the underlying. This can be extended to a portfolio in which the delta reflects the sensitivity of the portfolio to the underlying. It is usually the case that the delta is given to us by the software we use to trade.
The delta in its mathematical form is just the derivative of the option with respect to the underlying. The question to ask of course is how good is this number? if we are dealing with a big portfolio errors in the delta can be damaging in our assessment of exposure to movements of the underlying. The problem with the traditional delta that comes from the black and scholes formula, is that it assumes that trading is continuous and not discrete as it really is.
Discrete Delta
We can evaluate what is known as a “discrete” delta which can give us a better estimate of the true sensitivity. Here is an example. Suppose a stock is traded at $100 and a call option on that stock trades at $5. We note that when the stock goes up to 101, the price of the option goes up to $5.5. The delta in our case would be:
This is the essence of finding a “discrete” derivative. This would prove more accurate than the black scholes formula. This could be extended to even other “greeks” such as the gamma and vega.
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Published August 21st, 2007
in Uncategorized.
Hello guys,
Sorry for not updating the site in the last week. I am working on another program and of course you could download it for your enjoyment. It is some kind of a trading platform. I am also moving in the next hours the website to another database and I’ve been told the site would have to be down for 24 hours. So don’t panic if you can’t get into the site since it would be temporary. I’d make it up with a nice post about hedging risks though so stay tuned.
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Published August 7th, 2007
in Weekend Review.
The crazy roller coaster in the Israeli market and in the world markets made me very busy. The Israeli market was very volatile and exciting at the same time. A true trader thrives in these situations.
The public and press are always behind
A nice indicator I use, is what I call the crowed and press indicator. It is usually the case that if the public and press think a big decline is going to happen then it usually won’t happen and vice versa. The problem of course is to capture that sentiment. That is why I like to go to forums and see what is up with the people or get up to speed with all the financial press and analysts. It is not science but is gives me an idea. It was pretty funny to see that after the big decline that nobody had expected, the press was all over it saying that tomorrow there will be another big decline. This goes back to the black swan that people overestimate rare events after they happen and vice versa.
How it all went down
On the 25 of July, the market closed at 1166.63 which was a record high. The next day it went down to 1,137.12. A 2.5% decline. This set panic and caused the market to go down by 4% the next day. After that, there were talks about how the market would now crash and it was all expected. That is where you have to tell to yourself that the public is usually the last one to know anything about anything(including the financial press). For them, it was a big surprise that the market went up almost 3% in the next two days. After that, the roller coaster continued with ups and downs almost every day. Today the market closed at 1068 points. What is the lesson? Panic and Euphoria are good for traders.
Out-of-the-money options
I cannot go into specifics on how I exactly trade options, but I just want to say that the panic of the crowed could be exploited. Let’s just say that for some reason, the public always buys the deepest out-of-the-money puts in a decline.
Risk adjustments
I should make a bigger post on this one. Option traders use the delta to monitor their exposure in their position. The black and scholes delta could be way off than the real delta. A better way is to just observe the delta from the prices. This means seeing how much the price of an option changed relative to the change in the underlying. If you don’t fully understand what I mean don’t worry. I’ll make a bigger post on “discrete” greeks in the near future.
Final note
It has come to my knowledge that this blog was ranked in the Top 100 Day Trading Blogs. I am happy that people find what I write informative. That is on the top of my mind when I write each entry in here.
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