Exam 2016-FRR Topic 2 Question 186 Discussion

Actual exam question for GARP's 2016-FRR exam
Question #: 186
Topic #: 2

Which one of the following four statements best describes challenges of delta-normal method of mapping options positions?
Delta-normal method understates

A. Risks of long and short positions for both calls and puts. B. Risks of long option positions for puts and overstates risks of short option positions for calls. C. Risks of long option positions for calls and overstates risks of short option positions for puts. D. Risks of short option positions and overstates risks of long option positions for both calls and puts.

Suggested Answer: C Vote an answer

The delta-normal method, which uses the delta to approximate the change in the price of an option, has limitations when dealing with options. This method can significantly misrepresent the risks associated with options, particularly because it only considers the linear component of the price change (delta) and ignores the convexity (gamma). Specifically, it tends to understate the risks of long positions in calls because it does not fully account for the increasing delta as the underlying asset price rises, leading to potential underestimation of the risk. Conversely, it overstates the risks of short positions in puts, as the delta of puts decreases less dramatically when the price of the underlying asset falls.

by Donald at Sep 10, 2025, 03:07 AM

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