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Delta Hedging Using Covered Call: A Profitable and less Risky Investment Strategy

Author(s) : Vinoo Mathew

Volume & Issue : VOLUME 6 / 2018 , ISSUE 1

Page(s) : 5-11


Abstract

All of us are familiar with the term option contracts, the derivative instrument which are quite common among active traders. In Indian market scenario index options are much popular compared to stock options with a few exceptions. The derivatives market is considered to be a dangerous one and most of the traders who have started trading in derivatives have burnt their fingers just because of not understanding the concept of ‘time value’. The trades are executed through options contracts and that too an index option with the help of greek’s of options like delta, theta gamma and vega. As has been pointed out by a number of researchers, the normally calculated delta does not minimize the variance of changes in the value of a trader’s position. This is because there is a non-zero correlation between movements in the price of the underlying asset and movements in the asset’s volatility. The minimum variance delta takes account of both price changes and the expected change in volatility conditional on a price change. Delta is by far the most important hedge parameter and fortunately it is the one that can be most easily adjusted as it only requires a trade in the underlying asset. Implied volatility plays a major role in determining the fair value of an option contract and without understanding the impact of implied volatility options trading can be a night mare for most of the traders. One mistake that traders usually make is to ignore the implied volatility (IV) and only consider delta and theta. Option traders adjust delta frequently, making it close to zero, by trading the underlying asset. Arranging delta every now and then by initiating new trades would be a cumbersome process but the effort would be justified when it comes at a risk of 4-5%. The objective of this research paper is to find out ways by which a person who has knowledge about stock market can get decent returns. In this research paper the researcher has tried to introduce a financial model based on index options and futures contract which is less risky compared to naked futures positions in the market. The research paper analyses Black Scholes Model of option pricing and the pitfalls and differences associated with the original model using secondary data consisting of option prices and the value of nifty futures for the same period. Technical analysis software Metastock is used for deriving the values of option greeks. The study revealed that if a trader uses the time value of options wisely along with futures contract it can give the best possible result within a month’s time. A well-informed investor who is good in reading technical charts can easily make a return by using model of delta hedging strategy.

Keywords

Implied volatility, covered call, delta hedging, nifty, greeks, call option, put option, theta, gamma

References

Richard Lehman,Lawrence G. McMillan.(2003), New
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