Questions tagged [hedging]

[Think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn't prevent a negative event from happening, but if it does happen and you're properly hedged, the impact of the event is reduced. So, hedging occurs almost everywhere, and we see it everyday.](http://www.investopedia.com/articles/basics/03/080103.asp)

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47 views

Strategic Asset Allocation and Multi-Asset Class Option Based Tail Risk Hedging

If a Strategic Asset Allocation is defined as an asset allocation to weather all investment environments and one which should be employed in the absence of any market views, it would appear that the ...
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Do option values depend on whether a trader hedges with a long stock or short stock position?

Sheldon Natenburg in his book Option Volatility and Pricing in the chapter on Risk Management is trying to explain the effect of interest rates on options. He says The value of a stock option will ...
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Option seller: Why is delta hedging required if I am long/short the underlying with same number of lots as the OTM options I sold?

Situation: Sold OTM call while long the underlying. Stock did not tank, it went up too much breaching the breakeven point (strike price+premium). If I sell 1 lot of call options and I am being long ...
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221 views

Hedge backtesting: ex-ante Beta vs observed Beta (is this even possible?)

A global equity portfolio has for objective to outperform a benchmark (MSCI World). I hedge the sensitivity of the portfolio to MSCI World (the beta) so that only the alpha remains unhedged. The ex-...
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51 views

How to get exposure to realised volatility while being vega neutral?

Let's say I am predicting the realised volatility of a stock index. I am buying or selling straddles based on whether the predicted vol is higher or lower than the implied ATM volatility for the ...
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114 views

Why are equity futures so disconnected to the underlying index? Example

I am looking at ZWPH0 which is a future and the underlying index MSCI World. According to Bloomberg the prices are as follow: 13 March 2020: MSCI World 451 / ZWPH0 5234 16 March 2020: MSCI World 410 /...
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637 views

How do traders hedge against “tail side risk” in practice?

In a recent CNBC interview, Black Swan author Nassim Nicholas Taleb gave a categorical advice about investing in the Corona period. “It is very unwise to do any form of investment without some form of ...
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98 views

How can you possibly profit from hedging, in view of Algorithmic Trading?

To wit, doesn't hedging necessarily break even or lose money? I assume the semi-strong form of the EMH, defined in Zvi Bodie, Alex Kane, Alan J. Marcus. Investments (2018 11 edn). p 338.       The ...
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63 views

Hedging predicted volatility

Q. If you predict the volatility of the stock is 10% a year from now and current price is X dollar, how do you hedge the risk? Im not sure why I am finding this so hard. How do we use options (...
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Reason to hedge a European call option

Assume I write a call option on one share of the stock that I have. After selling the option I have an obligation to sell one share of the stock at some future time. I already have the stock, why ...
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80 views

Why would a 15Y swap index=EUR3M and discount=OIS, show only a EUR3M-delta at 15Y

When computing the index-delta for a swap in a multi-curve framework, only the last cash tenor seem to show sensitivity. Could anyone explain with formulas why it is the case ? For example a 15Y swap ...
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Hedging a long position-one period from Steven Shreve Stochastic Calculus for Finance

The following question is taken from Steven Shreve Volume 1, Chapter 1, Exercise $1.6$ (Hedging a long position-one period) Consider a one period binomial stock model with $S_0=4$, $S_1(H)=8$ and $...
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How do I hedge two/three zero coupon bonds with different maturity under Vasicek short rate model?

I am working on the case that I need to hedge two bonds with different maturites under Vasicek model, which is \begin{equation} dr_t=a(b-r_t)dt+\sigma dW^Q_t \end{equation} and I know how to price the ...
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Greeks: Why does my Monte Carlo give correct delta but incorrect gamma?

For a vanilla European call, my Monte Carlo method gives the right option price and delta but the wrong gamma. In particular, the value of gamma varies wildly each time I run the method. I estimate ...
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43 views

Managing/Hedging strangle with futures at strike prices

Since I am very new to options, I thought would be great to ask the opinions of the experts in this group. Please note that I will hold strangles till expiration. The goal is to sell strangles (OTM ...
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Hedging or Relative Value Strategies with Rho or Tau Correlations?

I understand that the Pearson correlation indicates the strength of linear relationship between two data sets. The applicability of this to hedging strategies is intuitive: If I can establish a linear ...
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Can the spread between option premium for bull call spread change over time?

I have created a bull call spread. There was spread of 70 dollars between the option premium of 2 strikes I selected. Now the spread between option premium of 2 strikes is greater than 100 dollars. ...
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81 views

Hedging an Inverse Product

We have two different products that follow the same price $S(t)$ for all time $t$. The payout for product one is given by $w_1(\frac{100}{S(t)} - \frac{100}{S(t + \Delta t)})$ and the payout for ...
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Alternative strategies for hedging customer FX positions in spot market

Generally, if an FX broker decides to hedge a customers' position, it automatically hedges the customer's trade to Liquidity Providers when the trade occurs in the spot market. Let's say, the customer ...
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135 views

Cash Flow Hedge Accounting

In the context of hedging a fixed rate foreign currency liability with a receive-fixed pay-fixed CCS is known that in order to assess the effectiveness of a cash flow hedge the ratio of the change in ...
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678 views

FX hedging: forward rate and implied forward rate

In this paper (box 1 page 24): https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Bulletins/2000/2000mar63-1brookeshargreaveslucaswhite.pdf It is argued that the forward rate that a ...
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Hedging a FVA in practice

A FVA (forward volatility agreement) is a forward contract on the ATM implied volatility. So at at maturity date $T$ the payoff of a FVA with unit notional is $$ (I_{ATM}(T,T') - K) $$ where $I_{ATM}(...
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Hedge robustness of the one factor Hull White model

I recently came across a quote in a book: "All single factor models share the limitation that shifts in curve levels cause shifts in the package of vanilla options that are a good hedge for the ...
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62 views

Repo sensitivity

Hope u're all doing well in this sanitary crisis. I have a question concerning repo sensitivity of basket/index derivatives regarding market making for instance. The argument to compute such a repo ...
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How can I theoretically hedge a bet, which is about whether or not price of a stock will get above a number?

For example, the bet may be about someone giving me P dollar and I will pay that person 300 dollars if tomorrow Tesla gets above 860 dollars. While assuming the Black-Scholes model hold, I can simply ...
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What put options would the Universa Tail Fund have bought?

According to this Bloomberg article, Universa was up 3,600% in March 2020, by hedging with extremely out-of-the-money puts: https://www.bloomberg.com/news/articles/2020-04-08/taleb-advised-universa-...
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184 views

Why do we not use copula for forward starting options?

Why do we use copulas for spread options but do not use them to correlate random variables across time, such as in the forward starting option?
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348 views

Confusion about replicating a call option

Assume standard Black-Scholes model, $$dS(t)=S(t)(rdt+\sigma dW(t))$$ where $\sigma$ is a constant and $W(t)$ is a Brownian motion under the risk neutral measure. A call option is replicable, so if we ...
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Hedging with different volatility (Ahmad and Wilmott paper)

In their paper they show that: - if you hedge with the realised volatility, the present value of the total p&l is the difference between the option value based on the realised volatility and the ...
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98 views

VIX vs S&P: Drift in the hedging residual?

I am looking at the daily returns of the VIX index (dVIX ) and the daily returns of the S&P 500 (dS). I am running a linear regression (using 0 intercept) and get a regression slope of -1.4, i.e. ...
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Question about using Ito's lemma in Gamma PnL

While deriving the delta hedge error if we hedge with implied vol, and the true vol is different, we say that the PnL of the call option is: $$dC=C_tdt+C_SdS+0.5C_{ss}<QV>dt - (1)$$ Where $<...
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81 views

PnL due to model recalibration and its relationship with hedging error

Consider the case where at t=0, I calibrate my model to the market, but at t=1 my model is no longer able to recover the price in the market, so it needs recalibration. Say I have delta hedged my ...
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Interest rate hedging using treasury futures – timing and duration

I'm pondering over the following (rather standard) problem: We have \$10 million invested in government bonds and are concerned with highly volatile interest rate over the next six months. We want to ...
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351 views

Who trades exchange options in practice (Margrabe's formula)?

I'm currently studying the pricing of the exchange option. https://en.wikipedia.org/wiki/Margrabe%27s_formula While I can appreciate the theory, who actually buys these options in practice? Are ...
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Should I hedge this spread with a spread option or an insurance product?

My firm generates electricity from wind. Accordingly, most of my generation takes place at night, when prices are low -- and, due to congestion / oversupply, often sharply negative -- so much so that ...
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84 views

Why do replicating strategies delta hedge?

We have a simple BS-market of one risky asset $S_{t}$, a bond $B_{t}$ and a digital option $X$ on the risky asset with value process $V(t,S_{t})$. I was able to derive $V(t,S_{t})$ using risk-neutral ...
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Garch models - are they useful for hedging? If so how?

I understand that Garch models are useful to predict volatility. But are they useful for hedging in practice? If I want to hedge volatility, why shouldn't I just use a Variance Swap? In other words, ...
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62 views

Cross hedge: Which commodity to hedge when you have to hedge the jet fuel price but you have option between two commodities

If we have an option between two commodities to hedge jet fuel and the commodities have results as follows: minimum variance hedge ratio: 1.07 for commodity 1 and 2.53 for commodity 2 ...
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717 views

Classic dynamic delta-gamma hedging in Python

I am trying to run a delta-gamma hedge for a Black-Scholes model in Python.The Euler disceretizatioin of the paths is the simplest possible. I wrote the code below but the PnL looks undesirable and ...
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Finding a PDE for an option $V(t,r(t),S(t))$

I have 2 approaches in my mind for finding a pde of an option that depends both on the short rate as well as the stock price- $V(t,r(t),S(t)$. Are these equivalent? Find a hedging portfolio by ...
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How does a pricing model 'understand' the cost of hedging?

Suppose I am pricing a multi asset at the expiry payoff. Theoretically I define their joint distributions in the risk neutral measure, and price using expectation. However, how do I know that the ...
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112 views

What kind of entities use exotic derivatives, and do they serve any purpose other than hedging risk?

I work in a sell-side bank in derivatives modeling. My work involves modeling and pricing of exotic derivatives and I often wonder who are the buyers of these products. From my research, I found that ...
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63 views

What are the differences between hedging with swaps, options or futures? [closed]

For instance if a bank wants to hedge against interest rate risk, it could use interest rate swaps, or options or futures contract. Or in any other example, when a manager is hedging against risks. ...
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43 views

How do I calculate FX forward hedge ratio?

Suppose I have a USD holding of 1,000,000 in my portfolio and I want to convert it into EUR in a month's time. I enter into a FX forward contract of the same amount USD 1,000,000, meaning that I have ...
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Why might a bulk annuity provider hedge their exposure to risks such as inflation, interest rates, and exchange rates on a weekly basis?

I was recently speaking to someone who works at a UK life insurer which offers defined benefit pension scheme buy-outs. He mentioned that the company employs traders (of bonds and swaps, mostly) and ...
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Why do (life) insurance companies face equity risk?

I am currently reading through a study published by the Institute and Faculty of Actuaries on hedging practices within the insurance industry. Within the executive summary, under 'Key Risks', it is ...
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Hedging with forward contract

I am wondering what strategies that can be used in hedging with forward contracts in commodities market. I only need to buy the forward contract (long position), let's say a one month contract. So my ...
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65 views

Can a portfolio value consisting of longing a delta shares of stocks and shorting a call option greater than strike price?

While trying to implement Black-Scholes delta hedging for a European call option using Python, I came across the following phenomena: Given a portfolio consisting of longing a delta shares of ...
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Vega hedging swaption with caplets - precisely, what will go wrong?

I am trying to form a kind of unified perspective of how (vega) hedging an exotic with vanillas, or hedging a 'basket option' with vanillas will go wrong. So in particular, I want to be able to ...
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277 views

Simple strategies for tail risk hedging that retail investors can use

Universa Investments run by Mark Spitznagel popularized the idea of portfolio insurance (also known as tail hedge) protecting the investor against severe market declines (tail risks). By using this ...

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