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Quantitative Finance by Matt Davison

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Chapter 26

Simulating Delta Hedging

26.1 CHAPTER SUMMARY

In this chapter we investigate the guts of Delta hedging through the use of a spreadsheet. We will see that the return of a delta hedged Long option portfolio is largely independent of the underlying stock return, explaining the mystery of where that parameter disappeared to in the Black Scholes equation and formula. We will also learn that, in the absence of transaction costs, the more frequently one can hedge, the lower the variance of the eventual profit and loss, but that transaction costs wreaks havoc on the returns of frequently rebalanced portfolios. Finally, we use the insights developed here to bring to life the trader’s saying “Big Gamma = Big Money.”

26.2 Introduction

In earlier ...

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