How traders manage their exposures
7 important questions on How traders manage their exposures
When do we say that a financial product is linear? Give an example.
Give an example of when a hedge-error may occur.
When we assume linearity between the stock price movement and the price of the call and we forget the 'curvature' of the option.
What does the Delta measure?
The Delta measures the rate of change of option value with respect to changes in the underlying asset's price. It's the first derivative of the value V of the option with respect to the underlying instrument's price S.
Delta = dV/dS
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Why is gamma an important risk measure?
Because it corrects for the convexity of value.
What does the Vega measure?
Vega measures sensitivity to volatility. Vega is the derivative of the option value with respect to the volatility of th underlying asset.
What does Theta measure?
Theta measures the sensitivity of the value of the derivative to the passage of time. (time decay)
What does Rho measure?
Rho measures sensitivity to the interest rate. It is the derivative of the option value with respect to the risk free interest rate.
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