What is convexity?
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What is convexity?
One of the benefits of buying options is convexity. When a stock drops one point, a call option with an initial delta of 50 percent will lose a half-point. But the option will now have a lower delta, such that the next point drop in the stock will result in a smaller loss for the option. This "positive curvature" helps reduce an option's price risk on each successive decline in the underlying shares, while the stockholder continues to lose the same one point on each successive drop in the stock. This positive curvature also works in the same manner as the stock moves up. A call option's delta will increase on each successive gain in the stock, allowing the call holder greater upside participation with each successive gain in the underlying share price. Convexity also refers to playing more dollars on successive trades during a winning streak and fewer dollars on successive trades in a losing streak. This preserves capital during a string a losses and provides greater participation during a hot streak.
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