Chapter 17
Options
Introduction
A fruitful application of the no-arbitrage principle mentioned in Chapter 1 is the approach of Black and Scholes to option pricing. As the payoff of an option can be replicated by a dynamic self-financing portfolio, the price of an option can be determined by the cost of that portfolio. We start this chapter with a brief sketch of that idea and tis implications for option pricing.
However, for trading purposes, delta hedging is particularly important when the gamma of the option is large. This leads to a segmentation of the volatility surface into a sector with high gamma (short expiry), where frequent hedge rebalancing is an important trading strategy, and into a sector with low gamma (long expiry) for which it ...
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