optiix

A manager would delta hedge a position to:

A) earn extra “dividend” income on a given position.

B) earn the risk-free rate.

C) place a floor on the position while leaving the potential for upside risk.

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A delta hedged position should earn the risk-free rate. The position does not earn a “dividend” although it should increase in value gradually (at the risk-free rate). The upside potential is limited to the risk-free rate. The manager would have to constantly monitor and adjust the position to achieve the goal.

optiix

A short position in naked calls on an asset can be delta hedged by:

A) shorting the underlying asset.

B) buying the put.

C) buying the underlying asset.

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Delta hedging a naked call can be accomplished by owning the underlying asset in an amount that will make the value of the short-call/long-asset portfolio immune to changes in the price of the underlying asset.

optiix

An option dealer is delta hedging a short call position on a stock. As the stock price increases, in order to maintain the hedge, the dealer would most likely have to:

A) buy T-bills.

B) sell some the shares of the stock.

C) buy more shares of the stock.

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As the value of the underlying increases, the delta of a call option increases. This means more of the underlying asset is needed to hedge the position.

optiix

In delta-hedging a call position, which of the following pairs of conditions would lead to the gamma effect being the most important? The call is:

A) at-the-money and has a long time until expiration.

B) out-of-the-money and near expiration.

C) at-the-money and near expiration.

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Gamma refers to the change in value of the delta given the change in value of the underlying stock. Gamma will be most important when the call option being hedged is either at the money or near expiration.

optiix

In delta-hedging, gamma would be important if the price of the underlying asset:

A) had a large move upward only.

B) remained constant.

C) had a large move upward or downward.

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Gamma refers to the change in value of delta given the change in value of the underlying stock. Typically, larger swings in the price of an asset will cause larger changes in delta, thus impacting the delta hedge. This means that the larger the move in the underlying asset in either direction, the more important is the second-order gamma effect.

optiix

All of the following are conditions that make the second-order gamma effect more important to a manager delta-hedging an option EXCEPT when the:

A) delta is near zero.

B) option is at-the-money.

C) option is near expiration.

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All of these conditions make the gamma effect more important except the delta being near zero. If the delta is near zero or one then the option delta will move more slowly towards zero or one and cause less of an affect on gamma.