Delta Hedge and Risk Free rate Delta, return, like

Howd

"Delta-hedged portfolio will earn a risk-free rate of return over time". The portfolio is like a covered call.

Is it due to time decay?

bkballa

I don't think time decay has anything to do. A delta hedged portfolio is simply immune from small mkt fluctuations on a daily basis, so should earn rfr, which become the beanchmark for valuation

cityboy

Is the position like a covered call? If completely delta hedged or delta neutral, the future value should be known for certain and you should be hedged against down or up moves in the underlying.

When the future price is known, you get the present value by discounting at the risk free rate. As such, by holding the position until expiration you are earning the risk free rate.



Edited 1 time(s). Last edit at Monday, April 4, 2011 at 05:42PM by jmac01.

strikethree

way too many derivatives questions. You should be eating your meat and potatos.

ll11

The short calls are not completely covered in a delta-hedge.

Thanks for the explanation.

Analyze_This

What if the stock goes down and the call is out of the money.

mcmc

deriv108 Wrote:
> Can the dealer sell out-of-the-money or
> in-the-money calls? Or Should they as the dealers?
> If yes, the delta of in-the-money call could
> increase over time.

Why not?
As you learned in level II, dealers need to dynamic hedging all the time when they do delta hedge (there are special softwares for that).

wake2000

"Yes they are. In a delta hedge, if the stock goes up by 1USD, the calls will go down by 1USD*delta (assuming the dealer is short). So overall the change in value of the portfolio is zero."

Delta is between 0 and 1. so, the delta must be 1 for the net change to be zero - meaning you are deep in the money. In that case, you may be delta neutral. right?

aidebaobao

I am not asking a question. Simply stating what I believe the answer to be and asking if you agree (since you were incorrect). May be getting lost in translation - guessing English may not be your first language.

And Level 2 was a breeze.

skycfa

jmac01 Wrote:
-------------------------------------------------------
> I am not asking a question. Simply stating what I
> believe the answer to be and asking if you agree
> (since you were incorrect). May be getting lost
> in translation - guessing English may not be your
> first language.
>
> And Level 2 was a breeze.


Yes I have heard that the 4th time you take level 2 it's a breeze. Your English must not be your first language because you obviously cannot understand the material. Go back and read level 2 books please.



Edited 1 time(s). Last edit at Tuesday, April 5, 2011 at 04:15PM by mik82.