I never studied Delta Hedging. I don’t care how securities are priced, it’s not part of my trading method which I talk about below.
I did study the Black Scholes option pricing model. Funny thing, the market does not use it to price options. The price is set by the market, by the order book. To adjust the BS price to the market price they invented “Implied volatility.” Implied? Not real?
The Black Scholes uses standard deviation, the bell curve, to guess the future. I’m not convinced that stock trading follows a normal distribution but more likely a power law distribution. Mike Klein’s charts show the real distribution vs. normal distribution.
Some are close but not all. Check it out yourself.
How accurate can the BS pricing be? Do the Black Scholes initials tell us anything?
Do you need BS to do Delta Hedging? NO! Delta is set by the market, by the order book!
Delta Hedging is a mechanical way to trade. I created my own way to trade. The object of the Call Option Selector is to fish the best option from the vast ocean of Option Chains to improve the portfolios performance.
The Captain
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Asked Google:
what is the practical use of the black sholes option pricing model?
The main principle behind the model is to hedge the option by buying and selling the underlying asset in a specific way to eliminate risk. This type of hedging is called “continuously revised delta hedging” and is the basis of more complicated hedging strategies such as those used by investment banks and hedge funds.
When you sell a call on your long stock position, you are giving up something of value in exchange for the $1000.
You are giving up the option to own the stock above the strike.
And we know from the theory of asset pricing that the value of that option does not depend on the net directional movement of the stock, it depends only on the volatility, the fluctuations of the stock.
Someone buying your call for $1000, if they sell short the stock and then delta hedge over the life of the option, they could, consistently, make more than $1000 from the delta hedge (plus interest earned on cash proceeds from the short sale plus interest earned on collateral posted to borrow the stock).
This outcome does not depend on the moneyness of the option at expiry.
They certainly will not lose $1000 like you describe, so it won’t be zero sum.
Once again you must include follow-up trades by the buyer of the option to justify your argument. I concede that complex systems change the Universe (a little bit).
A long term investor is better served by ignoring these predictions of doom and gloom. In the last 25 years, the world went through the dot com bust, great financial crisis, multiple wars, global pandemic, terrorist attacks.
Every year, uber bears come up with new therories about the imminent recession and depression and are wrong every time. It does not stop them from being negative.
Because I doubt you have a working time machine to alter the past, to visit the time the option was first sold when the whole thing was a wash.
If you go to the future who knows how many other trades it engenders and thus alters the future of the Universe. Why stop with my counterpart, he has counterparts who have counterparts who have counterparts until kingdom comes.
You sell a sandwich, someone buys it and eats it, thus realizing its value.
It’s strange to think that someone is buying calls that you sell and these calls have no value, but yet, somehow, there continues to be a market for these calls you are selling.
I didn’t say the calls have no value. The question was what the effect of the transaction was on the economy. Seller got the $1000 the buyer paid. Net effect on the economy NET ZERO.
$1,000.00 - $1,000.00 = $0.00
You are trying to create a value after the fact IF the players do some transacting. That may be but when the call was sold the net effect of the trade on the economy was NET ZERO.
I am explaining why that’s not true, regardless of the moneyness of the call at expiration.
The first reason is that the long call has value. (buy the sandwich)
The second reason is the call buyer can realize the value through expiration by delta hedging. (eat the sandwich)
And there are large, sustainable businesses built from those trades.
The thing of value that is being created is the call option. If you choose not to sell the call, then that thing of value doesn’t get created.
If all retail investors in the US stop trading options, then a bunch of wall street trading desks will lose a chunk of business and there will be economic consequences to many people.
