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YouTube T4-20: Market maker's delta-hedge illustrated

Nicole Seaman

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This market maker writes one call option (to the client) and hedges delta by purchasing Δ shares of the stock; this neutralizes delta but leave the market maker with a negative position gamma due to the short option position. The net profit, which is quantified in this video, on the position (i.e., short one call plus long one Δ share) is positive for short moves in the stock price but negative for large moves. There are four components to the market makers net gain/loss: interest received on cash from the short call, interest paid on the cash used to fund the purchase of the Δ share, positive theta (because time decay is a gain for the short option position!), and negative position gamma which overwhelms the other components as the magnitude of the stock movement (in either direction) increases.

David's XLS is here: https://trtl.bz/2O1OwKT


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