Why Does Speed Matter?

Example

• You buy 100 shares of a stock.  Each $1.00 your stock rises, you make 100 * 1.00 = $100.00.  Each $1.00 your stock falls, you lose $100.00.
• Alternatively, by buying call options you could make $300.00 when your stock rises by $1.00?  However, you can also lose $300.00 for every dollar the stock falls? 

This is the concept of leverage.

• You buy a stock at $50.00.  Buying 100 shares costs you $5,000.
• Let's compare this to buying the equivalent in call options: 1 contract at 7.00 will cost you $700.  (remember that 1 contract represents 100 shares for US stocks)
• For illustration purposes only , let's say that your delta is 1, ie for every one point the stock moves, the call option you've bought also moves by 1 point.

If the stock rises from $50.00 to $55.00:

• Your shares will increase by $5.00 per share and you'll make $500 in extra profit, a profit of 10%.
• Your calls will increase by 5.00 and you'll make $500 in profit, a profit of over 170%.

If the stock falls from $50.00 to $45.00:

• Your shares will decrease by $5.00 per share and you'll lose $500, a loss of 10%.  Out of the $5,000 you started with, you now have $4,500.
• Your options will decrease by 5.00 and you'll lose $500, a loss of over 70%.  Out of the $700 you started with, you now only have $200.

Can you now see why we might want to do something about the speed of the options price movements and why we might want to offset (or hedge) delta?

When we buy an option, we always want enough time to be right.  We also want to make sure that modest swings in the stock price aren't causing uncomfortably fast and wild movements in our options position.  This is why we want to hedge delta, or in other words, slow down the speed of the percentage movement of our options position compared with that of the underlying asset.