Hedging Effectiveness of Index Options in Sweden

Abstract: We test hedging performance of five different hedging techniques of the OMX Stockholm 30 (OMXS30) call options. Four of the hedging techniques applied are based on the Black-Scholes-Merton (BSM) model and the fifth is a regression-based model that adjusts the original BSM Greeks. Using market data from June 2007 to March 2011 we show that returns on the OMXS30 index are non-normally distributed and are inversely related to implied volatility. Analysis shows that hedge ratio adjustment for the inverse relation between implied volatility and stock price yields significantly better performance than the classical BSM delta and delta-gamma hedge. Delta adjustments for non-normal skewness and kurtosis provide better hedging performance than the BSM hedge ratio for all but ITM and deep ITM options. Empirical tests prove that the regression-based hedge ratio returns the lowest levels of hedging errors across all moneyness levels, maturities, and market regimes. We also find that the optimal hedge ratio is consistently lower than that suggested by the BSM model.