Lenny D. answered • 05/19/19
Financial Professional with many years of Wall Street Experience
Frankly, I don't see how it can. I have traded option portfolios for more than 30 years.
Lets define risk as the variance of your Daily P/L. If you have an option position or option portfolio the value will change if the price of the underlying changes (spot delta) forwards or Interest rates change (Forward delta) , Implied volatility changes (vol risk) and time (options decay.
If you are long a call option that is at the money and the underlying moves an average 2% on any given day the value of your call option will rise a little more than 1% on up days and fall a little less than 1% on down days It will not be exactly 1% as the delta will change when the underlying moves (this is called Gamma)
If you delta hedge the position. With the same move your hedge will make 1% when you position loses slightly less than and will make 1% when your position loses slightly less than 1%. This substantially reduces the variability of your p/l.
If The interest rate were to rise, the cost of delivering the underlying in the future rises. This will make the call more valuable.. If Rates were to fall the call would lose value. If we delta hedge with forwards or futures this risk is reduced which further reduces the variability of the daily P/L.
The Next hedge will cover several risk exposures.
If we hold a long option position it will lose value every day. Other thing equal this time decay increases as we get closer to maturity.
If the implied volatility embedded in the option price changes (these are constantly changing) then the value of my position in proportion to the change in implied volatility for at the money options and slight more for out of the money options when vol increases and slight less when vol decreases. If I sold a similar option (same maturity but different strike) and forward hedged) I will have substantially reduced my my, delta risk, vol risk and decay risk
Now, it is sometimes argued by brokers and sometimes put in textbooks that if you are short a put and you hedge and the stock price goes to infinity your losses could be infinite when if you had done nothing the put would have expired worthless. It should be noted that a delta hedged put has the exact same payout as a delta hedged call. A delta hedged short call position has much less risk than a naked short call.
This idea that naked short puts have led some brave(or misguided) to sell puts naked to collect premium. Sometimes people will sell puts 10% out of the money with the argument that if the stock drops 10% I would want to buy it. Typically, when a stock drops 10% something has changed which makes the stock less attractive and you wished you had owned puts instead.
If you ever have questions about options I have been involved in the options markets for more years than I care to count. Please reach out!!
