June 29th, 2015, 12:57 am
Suppose the option is on stock index. Since it is difficult to buy or sell stock index, index future is preferred for hedging the option. However, there are some different factors between index future an stock index. For example:1. Volatility. Future?s volatility is usually larger than stock index2. Dividend yield is implied by index future3. Basic risk may be large at certain period4. Usually front month contract of future is traded due to liquidity reason, rolling a future per month can introduce additional tracking error.So, is there any practical method to handle these?Thank you.