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Pastimes : Ask Mohan about the Market
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To: Joseph G. who wrote (8971)11/22/1997 2:59:00 PM
From: Rational  Read Replies (2) of 18056
 
Joe: This serious problem is discussed in Barron's today. Dealers can hedge against the delta risk by shorting [buying] the stock at the time they sell puts [calls]. With equal puts and calls and small stock price movements, dealers need no trading on the stock to hedge their option exposure.

But, with an appreciably large downward movement in stock prices (when the option value is no longer linear in the delta = percent change in the option value with respect to the stock price), dealers will have to short the stock, sufficiently, to hedge against rising put values, as calls become worthless providing no protection against the rapidly increasing put values. This short-selling (driven by programs) precipitate a further decline in prices giving rise to the domino effect of the kind we saw lately. Such a situation is more likely, when put option volumes rise as compared to call option volumes.

Sankar
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