Question

(i) Briefly explain the concepts of Gamma hedging and Gamma trading in options trading.

(ii) For European options, what is the relationship between the interest rate sensitivity of the call delta to that of the put delta?

Answer 1

Answer-

(i) Gamma hedging-

Gamma hedging is an options hedging strategy used to lessen the risk made when the basic security causes solid to up or down moves, especially during the most recent day or so before lapse.

Gamma hedging comprises of adding extra alternative agreements to an investors portfolio, as a rule rather than the current position. For instance, in the event that an enormous number of calls were being held in a position, at that point a broker may include a little put-alternative situation to balance an unforeseen drop in cost during the following 24-48 hours, or sell a deliberately picked number of call options at an alternate strike cost. Gamma hedging is a modern action that requires cautious figuring to be done effectively.

Gamma trading- Gamma trading truly alludes to the possibility of gamma supporting after some time and hoping to benefit from this versus the time rot in the options. Along these lines, a volatility trader may state, "I will sell a few options, trade the short gamma and hope to gather the time rot". What he implies by this is that he believes that his short gamma fences won't cost him as much as he will make from gathering the time rot from being short options. The estimation of options will in general fall after some time. This is known as the time rot of options. As the options come nearer to lapsing, their 'optionality' reduces. Out-of-the-cash options at termination are useless, yet before expiry they can have esteem since they may get an opportunity of lapsing in-the-cash. Be that as it may, over the long haul, this optionality needs to vanish. So in the event that one possesses a lot of out-of-the-cash options, one can hope to see their worth dissolve after some time, taking everything into account. The other side to this loss of significant worth through time rot is that by being long such options, one is long gamma. This is known as the 'gamma-theta trade-off'.

(ii)

Options contracts are utilized for hedging a portfolio. That is, the goal is to balanced potential unfavorable moves in different speculations. Options contracts are also utilized for speculating on whether an asset's cost may rise or fall.

So, a call option gives the holder of the option to purchase the fundamental asset while a put option allows the holder to sell the hidden asset.

Options can be worked out, meaning they can be changed over to shares of the basic asset at a predetermined cost called the strike cost. Each option has an end date called an expiration date, and an expense or value associated with it called the premium. The premium or cost of an option is usually based on an option evaluating model, similar to Black-Scholes, which leads to fluctuations in cost. Greeks are usually seen related to an option value model to help understand and gauge associated hazards.

Interest rates assume an irrelevant part in a situation during the life of most choice exchanges. In any case, a lesser-known Greek, rho, gauges the effect of changes in interest rates on an alternative's cost.

Typically, higher interest rates settle on call options more costly and put options more affordable, all taking everything into account.