Hedging Options » Hedging

Hedging â What is It, and Itâs Uses in Risk Management

admin — Thu, 14 Jan 2010 19:27:06 +0000

The second of a two part articleâ¦. Before I discuss the use of hedging to off-set risk, we need to understand the role and the purpose of hedging. The history of modern futures trading begins in Chicago in the early 1800âs. Chicago is located at the base of the Great Lakes, close to the farmlands and cattle country of the U.S. Midwest making it a natural center for transportation, distribution and trading of agricultural produce. Gluts and shortages of these products caused chaotic fluctuations in price. This led to the development of a market enabling grain merchants, processors, and agriculture companies to trade in contracts to insulate them from the risk of adverse price change and enable them to hedge. The first commodity exchange was the creation of the Chicago Board of Trade, CBOT in 1848. Since then, modern derivative products have grown to include more than the agricultural industry. Products include Stock Indices, Interest Rates, Currency, Precious Metals, Oil and Gas, Steel and a host of others. The origins of the commodity and futures exchange was created to support hedging. The role of speculators is beneficial as they add trading volume and important volatility to what would otherwise be a small and illiquid market place. You can view a complete listing of the worlds different exchanges at: http://www.genuinecta.com/World_Exchanges_Commodities_Trading_Advisors.htm A bona-fide hedger is someone with an actual product to buy or sell. The hedger establishes an off-setting position on the futures or commodity exchange, thereby instituting a set price for his product. Someone buying a hedge is known as being âLongâ or âTaking Deliveryâ. Someone selling a hedge is known as being âShortâ or âMaking Deliveryâ. These positions known as âContractsâ are legally binding and enforced by the exchange. Entering your trades either for speculation or hedging is done through your broker. Commodity Trading Advisor, Genuine Trading Solutions President Dwayne Strocen, states that âCommodity and Futures exchanges are distinct from Stock Exchanges, although they operate using the same principals. They are regulated by different agencies such as the Commodity Futures Trading Commission who are responsible for regulation of retail brokers in the USA as well as Commodity Trading Advisors such as us.â Now letâs view some real life examples of hedging or mitigation of risk by using exchange traded derivatives. Example 1: A mutual fund manager has a portfolio valued at $10 million closely resembling the S&P 500 index. The Portfolio Manager believes the economy is worsening with deteriorating corporate returns. The next two to three weeks are reports of quarterly corporate earnings. Until the report exposes which companies have poor earnings, he is concerned of the results from a short term general market correction. Without the privilege of foresight, he is unsure of the magnitude the earnings figures will produce. He now has an exposure to Market Risk. The manager thinks of his options. The greatest risk is to do nothing, if the market falls as expected, he risks giving up all recent gains. If he sells his portfolio early, he also risks being wrong and missing further rallyâs. Selling also incurs substantial brokerage fees with additional fees to buy back again later. Then he realizes a hedge is the best option to mitigate his short term risk. He begins by calling his CTA (Commodity Trading Advisor) and after consultation places an order to sell short the equivalent of $10 million of the S&P 500 index on the Chicago Mercantile Exchange âCMEâ. Now his result is when the market falls as expected, he will off-set any losses in the portfolio with gains from the Index hedge. Should the earnings report be better than expected, and his portfolio continues upward, he will continue making profits. Two weeks later the fund manager calls his CTA and closes the hedge by buying back the equivalent number of contracts on the CME. Regardless of the resulting market events, the mutual fund manager was protected during the period of short term volatility. There was no risk to the portfolio. Example 2: An electronics firm ABC has recently signed an order to deliver $5 million in electronic components of next years model to an overseas retailer located in Europe. These components will be built in 6 months for delivery two months after that. ABC instantly realizes they are exposed to two risks. 1. the rising and volatile price of copper in 6 months may result in losses to the firm. 2. the fluctuation in the currency could easily add to those losses. ABC being a young firm cannot absorb these losses in view of the highly competitive market from others in the field. Losses from this order would result in lay-offs and possibly plant closures. ABC telephones their CTA and after consultation places an order for two hedges, both for an expiry in 8 months, the date of delivery. Hedge #1 is to buy long $5 million of copper effectively locking in todayâs price against further price increases. ABC has now eliminated all price risk. The risk of plant closures is greater than the lure of increased profit should copper price fall. After all, ABC is not in the business of speculating on copper prices. Hedge #2 is to sell short the equivalent of Euro Currency vs US Dollars. Since ABC is effectively accepting EC in payment, a rising US dollar and a weak EC would be detrimental and erode profits further. The result of the hedge is no risk and no surprises to ABC in either copper or currency levels. A risk free transaction and full transparency is the result. In 8 months with the order completed and the customer accepting delivery, ABC notifies the CTA to close the hedge by selling the copper and buying back the Euro Currency contacts. Many examples exist to demonstrate the mitigation of risk to an institution or financial portfolio. Dwayne Strocen states that new products are constantly created and available on both over-the counter and exchange traded markets. If would be wise to consult with a qualified Commodity Trading Advisor or broker to discuss the analysis for an on-going risk management solution or a one time only hedge.

Option Hedging: Dynamic and Static Replication of Standard and Barrier Options, and Risk Management of Options on More Accurate Sensit (Impulse) (Hardcover)

admin — Mon, 11 Jan 2010 18:38:50 +0000

No description for this product could be found, but have a look over at Amazon for reviews and other information.

Currency Derivatives: Pricing Theory, Exotic Options, and Hedging Applications (Kindle Edition)

admin — Fri, 08 Jan 2010 21:53:36 +0000

A groundbreaking collection on currency derivatives, including pricing theory and hedging applications. “David DeRosa has assembled an outstanding collection of works on foreign exchange derivatives. It surely will become required reading for both students and option traders.”—Mark B. Garman President, Financial Engineering Associates, Inc. Emeritus Professor, University of California, Berkeley. “A comprehensive selection of the major references in currency option pricing.”—Nassim Taleb. Senior trading advisor, Paribas Author, Dynamic Hedging: Managing Vanilla and Exotic Options. “A useful compilation of articles on currency derivatives, going from the essential to the esoteric.”—Philippe Jorion Professor of Finance, University of California, Irvine Author, Value at Risk: The New Benchmark for Controlling Market Risk. Every investment practitioner knows of the enormous impact that the Black-Scholes option pricing model has had on investment an (more…)

The Options Applications Handbook: Hedging and Speculating Techniques for Professional Investors (McGraw-Hill Financial Education Series) (Hardcover)

admin — Tue, 05 Jan 2010 12:54:36 +0000

The Options Applications Handbook offers a lucid, down-to-earth introduction to the fundamentals of options, explaining how options can be used for various purposes, such as options on exchange rates, interest rates, stocks, futures, and fixed-income securities. With the help of this on-target guide, readers will be able to understand basic option types…use standard market terminology…grasp the costs, benefits, and risks of basic option positions…identify key factors that affect the price of an option…and see how pricing models have been modified for specialized options. The Options Applications Handbook covers in detail: Conventional Options_focuses on the mechanics of call and put options, basic option payoff profiles, and the creation of synthetic options/assets Exotic Options_explores second generation option contracts, such as path dependent options and path independent derivatives, that build on the basic struc (more…)

Gold Investing: A Hedge Against Inflation

admin — Sat, 02 Jan 2010 19:04:09 +0000

Gold Investment is an old age tactic of putting your money into something that you feel will increase in value over time. It is a liquid and tangible investment. There are so many motives behind gold investment. Some invest in the hope of future increment in the value, some because they love the yellow metal, some other for price speculation and so on.
Gold is slightly more risky than bonds, so you should be careful to pay attention to this. However, as a long term investing strategy, gold has steadily increased in value over time. Also, part of the reason that gold is worth so much money is due to its comparative rarity. Even though it is rare, If the markets were to become flooded, chances are good that you would lose money. However, gold has a tendency to stay relatively stable, or to increase its value, over time. The rarity of gold is what keeps it’s value up.
It can be a trading item, store of value, investment, insurance and others. You have the options of investing in gold, gold stock, gold bullion, gold certificates, options, forward contracts, gold linked notes and such other gold related options. Trading gold has also been an old established business. Trading may be like other currencies for future appreciation in the value.
How stable is gold investing? Well, the demand for gold is much higher than its supply. As you can tell, this is already good for people who are thinking about gold investing. Once there is more supply than demand, the price starts to rise. Since the demand for gold is almost twice the amount that is actually mined, the prices for gold are likely to go up steadily.
Speculation is the main cause for trading. There may be different types of gold investors like people who store gold, people who include in their portfolio, banks who keep part of their deposit in gold, financial institutions, gold bugs, speculator, petroleum speculator, portfolio hedger etc.
Gold may be included in your investment portfolio. But with other investment strategy, gold investment should be a part of your portfolio not the whole portfolio. Exposure to only one kind of investment can have negative effects should you run into a down time. You can invest in gold but with some research and knowledge. Investing is interesting but may be destructive for your investments. Like stock investing, in gold investing also you should do research and fundamental and technical analysis.
Just like diversifying your total investment portfolio, one thing that you should keep in mind about gold investing, is that you should not put all of your money into one type of gold investment. You should also not just go out and buy a bunch of physical gold. While this is a good way to build a solid and insured foundation, you should also be investing in some of the other parts of the gold industry. For instance, if you invest in gold mines that are not producing at their top amount yet, or in potential gold mines, you stand a chance of making more money in the future.
Gold values are currently at all time highs as the US dollar weakens in value, and oil prices continue to rise. The perfect time to invest in gold would have been a few years ago up to last year, however, timing the market is not the best strategy for non active investors. Dollar cost averaging is best for non active investors. What you would do is purchase gold in even increments over time, and the over all average cost of the acquisitions lowers as you buy gold in up times, as well as down times.

Trading and Hedging with Agricultural Futures and Options (Hardcover)

admin — Sun, 27 Dec 2009 15:40:23 +0000

Today’s Premier Guidebook for Understanding Agricultural Options and Making Them a Key Part of Your Trading and Risk Management Strategy Agricultural futures and options represent a vital niche in today’s options trading world. Trading and Hedging with Agricultural Futures and Options takes an in-depth look at these valuable trading tools, and presents clear, proven strategies and techniques for both hedgers and traders to achieve their goals while minimizing risk. Relying on nuts-and-bolts techniques and examples as opposed to the mathematical models and theory favored by other options-trading manuals this practical, hands-on book discusses many topics, including: How hedgers and traders can use options effectively with realistic expectations Methods to understand price behavior including the Greeks (delta, gamma, vega, and theta) The importance of volatility and little-known ways to make it work to your advantage For producers and processors, agricultural futures and (more…)

Commodity Options: Trading and Hedging Volatility in the World??Ts Most Lucrative Market (Kindle Edition)

admin — Mon, 21 Dec 2009 14:33:22 +0000

This is the eBook version of the printed book. If the print book includes a CD-ROM, this content is not included within the eBook version.Don’t Miss out on Today’s Hottest Trading Arena: Commodity Options! Investors worldwide are discovering the enormous opportunities available through commodity options trading. However, because commodities have differing underlying characteristics from equities, commodity options behave differently as well. In this book, two of the field’s most respected analysts present strategies built from the ground up for commodity options. Carley Garner and Paul Brittain begin with a quick primer on how commodity options work, how they evolved, and why conventional options strategies often fail in the commodity options markets. Next, using detailed examples based on their own extensive research, they show how to leverage the unique characteristics of commodity options in your own trades. You’ll walk through trades from “top to bott (more…)

Commodity Options: Trading and Hedging Volatility in the World’s Most Lucrative Market (Hardcover)

admin — Fri, 18 Dec 2009 11:50:27 +0000

Don’t Miss out on Today’s Hottest Trading Arena: Commodity Options! “The authors have written the definitive work on trading commodity options. Their in-depth knowledge of this subject is legendary among industry professionals and expert traders alike, and their ability to relay their knowledge through text, pictures, and the spoken word is unparalleled in our industry.” –Lan Turner, CEO, Gecko Software, Inc. “This book captures the realities of commodity option trading in a simple and easy- to-read presentation that will be beneficial for traders of all sizes and skill levels.” –Chris Jarvis, CFA, CMT, Caprock Risk Management, LLC “Even the most experienced investors often overlook the fact that options on futures are fundamentally different from options on stocks. This book fills that gap and sets the record straight with clear and concise descriptions that are easy to understand. Guaranteed to become a true source of value creation for anyone interested in tradin (more…)

Hedging of My Forex Positions Using Binary Options

admin — Fri, 18 Dec 2009 07:22:11 +0000

Non-farm payroll (NFP) number is being released today at the exact same time that ECB President Trichet begins his press conference, which means that we could see unusual volatility at the morning of US hours. The ECB press conference and the Non-farm payroll report will either neutralize each other or be a toxic combination for the US dollar.Trading the Non-farm payroll is usually very difficult given the inherent volatility of the currency pair but given the 2 big event risks – the ECB rate decision and the NFP release.The market currently expects a bad number, so a negative non-farm payrolls report will not be enough of a surprise. The current forecast calls for 60k jobs to be shaved off US payrolls. If payrolls come any where near -90k, the dollar would collapse against the Euro as the market questions the viability of a 2008 rate hike by the Federal Reserve. If payrolls on the other hand are better than -40k, it suggests that the labor market is bad but not as bad as everyone may have feared, which would be dollar positive. Currently I am holding 2 forex positions: 1. Shorted 100,000 NZD/USD at 0.7605, stop at 0.7645, target level at 0.7570. Current price is 0.7604, unrealised gain is US$6.2. Bought 100,000 USD/CHF at 1.0154, stop at 1.0120, target level at 1.0200. Current price is 1.0159, unrealised gain is US$58.22.Since I do not know the outcome Non-farm payroll and the ECB press conference, there are a few ways to reduce my risk:a) I can close my positions before the announcement can miss out the opportunity to profit when my initial view is correct. b) I can adjust my stop closer to my cost level but the great volatility from post NFP announcement can easily trigger stop to my positions. c) I can hedge my position using binary options.Binary option trading platform: IG Markets.1. Since I had shorted NZD/USD, I had bought Over for the binary option. So this means that in the situation that NZD/USD rises, I lost money from my convention forex position, at least I still win some money from my binary option.I had bought US$80 for NZD/USD Over trade for Daily expiration, strike price is 0.7649, odds is 3. This means if NZD/USD goes above 0.7649 by 5am China time, I will win US$240. If not I will lose US$80, but I may gain much more from my forex position.

2. I had done the same for USD/CHF. Since I had bought NZD/USD, I had bought US$80 Under for the binary option. So this means that in the situation that USD/CHF falls, I lost money from my convention forex position, at least I still win some money from my binary option.I had bought US$80 for USD/CHF Under trade for Daily expiration, strike price is 1.014, odds is 1.78. This means if USD/CHF goes below 1.014 by 5am China time, I will win US$142.40. If not I will lose US$80, but again I may gain much more from my forex position.

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The Art of Hedging in Options Trading

admin — Sat, 12 Dec 2009 21:02:55 +0000

A hedge is an investment made to offset the risk incurred by entering another investment. Essentially you are setting up a bet on both sides so that one offsets the other and you can end up winning either way.
Think of it as a form of insurance.
Options are frequently used in hedging.
For example, you can speculate that the market price will rise in the future and buy a call today. But, because the market is uncertain and you’re not certain it will rise, you simultaneously buy a put option.
By carefully selecting the appropriate combinations of strike price, expiration date and type of option an investor can minimize risk and maximize the probability of making a profit.
So how does it all work?
Well let’s take a look at a common hedging strategy: the Strangle.
In this strategy, an investor holds both call and put options with the same maturity, but with different strike prices.
The contracts are purchased ‘out of the money’ and are therefore cheaper. ‘Out of the money’ means the strike price of the underlying asset is higher (for a call) or lower (for a put) than the current market price.
For example let’s say Intel (INTC) is currently trading at $40 per share. You could buy one call at $3 and one put at $2 with the call having a strike price of $45, the put $35. Your total investment would be ($3 x 100) + ($2 x 100) = $500.
If the price over the length of the contracts stays between $35 and $45 the total possible loss = $500, the cost of the options. So your risk in this kind of hedge is limited to $500.
Suppose the price drops near expiration to $25. The call would expire worthless, but the put is worth ($35-$25) x 100 = $1000 – ($2 x 100) = $800. Subtract the cost of the call, $800 – $300 = $500. So that’s your net profit (ignoring commissions and taxes).
The difference between the exposure and the potential profit represents a kind of hedge. Though you are essentially ‘betting’ that the price could go either way, your downside is limited to the combined cost of the put and the call.
There are, not surprisingly, nearly as many hedging strategies as there are investors. A couple of common types are:
The collar: Hold the underlying asset and simultaneously both buy a put and sell a call of the same asset. The short call limits gains, but the long put hedges against any losses from the underlying asset.
The protective put: Buy the asset and also buy a put option on the same asset. At expiration, the asset may have gained (eliminating the value of the put option), but the rise in the asset offsets the loss.
And there are a whole host of other variations. Most do involve speculating on the price direction of the underlying asset, while taking advantage of the leverage, cost and timing characteristics of options. As with any investment strategy, make sure you understand the pros and cons before laying down your bet.