Managing Option Trading Risk when Mental Accounting Influences Prices

27 Pages Posted: 12 Jan 2014 Last revised: 10 Jun 2016

See all articles by Hammad Siddiqi

Hammad Siddiqi

University of the Sunshine Coast-School of Business

Date Written: November 24, 2013

Abstract

Experimental evidence and opinions of market professionals suggest that mental accounting influences option prices. I explore the implications of mental accounting of a call option with its underlying for risk management. If mental accounting influences prices and the Black Scholes approach is used, then for in-the-money call options, delta-risk is under-estimated, gamma-risk is over-estimated, and the extent of time decay is under-estimated. Covered call writing is significantly more profitable with mental accounting than without it. Formulas for Greeks adjusted for mental accounting are put forward.

Keywords: Mental Accounting, Greeks, Options, Delta, Gamma, Theta, Covered Call

JEL Classification: G13, G12

Suggested Citation

Siddiqi, Hammad, Managing Option Trading Risk when Mental Accounting Influences Prices (November 24, 2013). Journal of Risk, 2015. Available at SSRN: https://ssrn.com/abstract=2377889 or http://dx.doi.org/10.2139/ssrn.2377889

Hammad Siddiqi (Contact Author)

University of the Sunshine Coast-School of Business ( email )

Brisbane, QLD 70010
Australia
+61404900497 (Phone)

HOME PAGE: http://www.usc.edu.au/staff-repository/dr-hammad-siddiqi

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