Covariance

kaushalya.narendran
Posts: 7
Joined: Sat Jan 11, 2014 2:11 pm

Covariance

Postby kaushalya.narendran » Wed Jan 22, 2014 5:30 am

Why is the covariance between the returns of a stock and a put option on the stock negative?

pradeeppdy
Finance Junkie
Posts: 258
Joined: Thu Sep 20, 2012 3:42 pm

Covariance

Postby pradeeppdy » Tue Jan 28, 2014 10:15 am

If the stock is moving upside, then put option will be devalued because it is a protection to downside risk.
Hence they have negative covariance because both are moving in opposite direction.

pradeeppdy
Finance Junkie
Posts: 258
Joined: Thu Sep 20, 2012 3:42 pm

Covariance

Postby pradeeppdy » Wed Apr 02, 2014 7:38 am

The covariance defines the variability between returns of two assets . If both move up or down simultaneously so covariance is +ve . If both move in the opposite direction then the covariance is -ve. Here in this case the relation of covariance is such that if the asset returns increase the value of put option premiums come down and vice versa. So covariance is -ve.


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