Question

In Financial Derivatives:

Explain the practical issues and difficulties when using Gamma, Delta and Vega and why they are an important source of information to both an option’s speculator and an option’s market maker, who (each) trade many options, written on different underlying assets. (You may use illustrative equations and numbers in your answer).

Answer 1

1. Delta is important for both options maket maker and speculator.

Delta option simply means sensitivity of price of options to changes in the market price of the underlying assets. It helps in reducing risk of price movements in the underlying assets.It keeps changing over a period of time depending upon volatility, interest rate and time of maturity.

Different traders use different scales for measuring option delta. some use 0-1 others 0-100 scale..so a delta value 0.6 will be equivalent to 60 on the other scale but underlying concept remains the same.

Delta option is positive for call option and negative for put option. Which means rise in price of stock is positive for call option and negative for put option.

2. Gamma is important

Gamma measures movement risk. It tells us how delta measures of sensitivity of changes in understanding assets depending on volatility interest rate etc..delta measures the option premium while gamma momentum. like delta Gamma will range from 0- 1..it is also linked to whether your option is long or short in the market.

3. Vega is important

It measures the change in option value to change in volatility of the underlying assets price process..

Example if vega of call option is 17.35 whereas volatility of underlying assets process is 25%

It means volatility increase by 0.01 hence predicted increase is 0.01x 17.35 = .1735

Vega gives the option traders insight to how the positive value are exposed to volatility.