Professional Documents
Culture Documents
using
Outline
Introduction
Using
options
Using futures contracts
Dynamic hedging
Introduction
Portfolio
Hedging
Using Options
Introduction
Equity
Introduction
Options
Knowledge
of delta
Protective puts
Protective put profit and loss diagram
Writing covered calls
Black-Scholes Formula
(European Options)
C S0 e
P Ke
qT
rT
N (d1 ) Ke
rT
N (d 2 ) S0e
N (d 2 )
qT
N (d1 )
where
ln( S0 / K ) (r q 2 / 2)T
d1
T
d 2 d1 T
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Importance of Delta
Delta
Protective Puts
A
Protective
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Protective Put
Profit and Loss Diagram
Assume
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Protective Put
Profit & Loss Diagram (contd)
Long
Profit or Loss
0
Stock Price at
Option Expiration
-50
$50
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Protective Put
Profit & Loss Diagram (contd)
Long
Profit or Loss
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0
-1
Maximum
Loss = $1
Stock Price at
Option Expiration
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Protective Put
Profit & Loss Diagram (contd)
Protective
put diagram:
Profit or Loss
-6
Maximum
Gain is unlimited
$45
Maximum
Loss = $6
Stock Price at
Option Expiration
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Protective Put
Profit & Loss Diagram (contd)
Observations:
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Protective Put
Profit & Loss Diagram (contd)
Selecting
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The
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Differences
Index Options
Investors
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24
While
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Portfolio value
1
HR
Portfolio beta
Contract "value"
Delta
$150, 000
1
1.20
$32,719
0.235
23.41
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Example #2 (Contd)
Suppose
What
Example #2 (Contd)
Suppose
What
Example #2 (Contd)
Terminal
Example #2 (Contd)
Thus:
Rindex = (Rportfolio-Rf)/beta + Rf
So Rindex = (-9-3)/2+3 = -3%
Dividends from index = (3/12)(4) = 1%
Change in index value = -3-1 = -4%
Terminal index value = 1000(1-.04) = 960
Therefore we need an index put option with
a strike price of 960.
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Example #2 (Contd)
And
Example #2 (end)
Also
of financial futures
Stock index futures contracts
S&P 500 stock index futures contract
Hedging with stock index futures
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Importance of
Financial Futures
Financial
The
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Stock
Hedging with
Stock Index Futures
With
S&P
Hedging with
Stock Index Futures (contd)
To
Hedging with
Stock Index Futures (contd)
Determine
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market falls
The market rises
The market is unchanged
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Computation
A
Computation (contd)
The
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Computation (contd)
Example
You are managing a $90 million portfolio with a beta of
1.50. The portfolio is well-diversified and you want to
short S&P 500 futures to hedge the portfolio. S&P 500
futures are currently trading for 353.00.
How many S&P 500 stock index futures should you short
to hedge the portfolio?
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Computation (contd)
Example (contd)
Solution: Calculate the hedge ratio:
1.50
250 $353
1,529.75
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Computation (contd)
Example (contd)
Solution: The hedge ratio indicates that you need 1,530
S&P 500 stock index futures contracts to hedge the
portfolio.
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50
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Hedging in Retrospect
Futures
Dynamic Hedging
Definition
Dynamic
hedging example
The dynamic part of the hedge
Dynamic hedging with futures contracts
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Definition
Dynamic hedging involves monitoring a portfolio's
position delta and readjusting this value as it
deviates from a target number.
Example:
Attempt to replicate a put option
By combining a short position with a long position
To achieve a position delta equal to that which would
be obtained via protective puts
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Dynamic Hedging
Example (contd)
You
Dynamic Hedging
Example (contd)
The
Dynamic Hedging
Example (contd)
With
You
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Stock
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that:
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1.0
250 $700
300 contracts
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