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Strategies & Market Trends : Stock Attack -- A Complete Analysis -- Ignore unavailable to you. Want to Upgrade?

To: Electric who wrote (11766)	7/10/1998 6:32:00 PM
From: Robert Graham	Respond to of 42787

Implied volatility and delta are related. The greater the implied volatility, the greater the (assumed) chance is for the option to close in-the-money. So as a result there is a higher time premium for the option. As the price of the stock approaches the strike price of the option, the delta will go up from lets say 2/10 of a point. The size of the delta is also related to the probability of the option expiring in-the-money. It goes up as the stock price approaches the strike price. A rule of thumb is looking at a delta of 2/10 to indicate that at this point in time there is a 20% probability of the option expiring in-the-money. This ratio provided by the delta of an option can be used in a delta neutral hedging strategy in determining the quantity of the option with a given delta to purchase in order to hedge a position. As time goes by to deteriorate the premium on the option, or as the stock price approaches the strike price of the option, the delta will change. So adjustments will have to be made to this delta neutral position. The MM would prefer to use synthetic positions to hedge their MM activities in their efforts of providing liquidity to the market. But this may not be possible, particularly in the more illiquid option markets. In this situation where synthetic positions are not workable, there are delta neutral trading strategies that the MM use to manage risk. I have seen this improperly written up as "risk free" option positions. In actuality this type of position is an attempt only to minimize the effect of market direction on a position, but for instance cannot provide adequate protection from large and quick transitions in price. Delta neutral trades take place in the setting up of long straddle/strangle, the long and short butterfly, and the long wrangle with respect to their open option positions. Delta neutral trading strategies are the favored approach by MMs since they are making a profit on the spread and not speculating on market direction. So they would use the advantage that the delta neutral trading strategies would provide them. But as we have seen, MM can strategically use market bias to their advantage. I think I am saying too much in my posts! Bob Graham