Page 175 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes 12.6 Keywords

Arbitrage: Arbitrage refers to riskless profit earned by taking positions in spot/futures markets.
Delta: Delta is a measure of the sensitivity the calculated option value has to small changes in
the share price.
Gamma: Gamma is a measure of the calculated delta's sensitivity to small changes in share price.
Sensitivity analysis: The sensitivity analysis of option premium deals with the measurement of
changes in option price due to the change in the underlying parameters that determine the
option prices.
Vega: Vega measures the calculated option value's sensitivity to small changes in volatility.

12.7 Review Questions

1. List and explain the various option Greeks. Discuss their significance in relation to option
valuation.
2. The delta of an option tells you by how much the premium of the option would increase
or decrease for a unit change in the price of the underlying. How?
3. Define Theta. How is it calculated? Discuss the variations of theta of a European call option.
4. Identify the three main issues involved in hedging using futures contracts.

5. What do you mean by 'going short'? Take a numerical example to illustrate the usage of
'going short' in futures contracts for hedging purpose.
6. What is a short hedge? List its features and present its profit-loss pattern, by taking an
example.
7. Explain in detail the basic steps involved in the hedging strategy using futures contracts.
8. Can futures contracts be used for speculation benefits? Support your answer with suitable
numerical illustrations.
9. What do understand by 'arbitrage?' How can futures be useful for arbitrage gains?
10. Speculators can also benefit from trading in futures contracts. When the underlying asset
is expected to be bullish (rising prices), the speculator opts for buying futures; whereas
when the underlying asset is expected to be bearish (falling prices), the speculator opts for
buying futures. Discuss.

Answers: Self Assessment

1. in-the-money 2. volatility
3. premium 4. Vega

5. delta's sensitivity 6. commodity
7. futures contract 8. False
9. False 10. True
11. True 12. True

13. Arbitrage 14. buying
15. selling 12.8 Further Readings

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