Dynamic Hedging
Hedge entire portfolio with one or two trades.
What is hedging? A process that protects position from adverse movements. Making a trade that counters the direction of the primary trade. Many positions are naturally hedged (spreads, married put, most synthetics). Doesn’t mean position can’t lose money but limits amount that can be lost and thus the risk.
Key Points
- Hedging is not eliminating risk — but limiting it to a comfortable point.
- The hedge side of a trade is a losing but important aspect because for a small extra cost you’re protected It’s like ife insurance, car insurance, and other money you spend just in case…
- Since there’s always a chance of being wrong, better to make a little less and be protected
- Long positions are automatically hedged because your loss is limited to what you paid for the position
- Short positions are unhedged because if you are assigned you have to purchase the stock at whatever price is currently trading at.
Hedging Examples
- Stock direction can be hedged by delta
- Volatility can be hedged by vega
- Time decay can be hedged by theta
October 14, 2007
Conferences