1. Hedging Strategies
Stefano Grazioli

2. Critical Thinking Easy meter
Extra help: office hours tonight 5:30 onwards

3. You do the talking Name, major… Learning objectives
Things you like about the class
Things that can be improved
Attitude towards the Tournament

4. Financial Strategies: Basics
Stefano Grazioli

5. Payoff Curves
Going long / short = flipping horizontally the payoff curve
Profit & Loss
Profit & Loss
long
$10
price at which you bought it
short
$10
Stock price
Stock price

6. Call and Put Payoffs long call short call short put long put
Profit & Loss
long call
Profit & Loss
Stock price
short call
Stock price
strike
strike
Profit & Loss
Profit & Loss
short put
long put
Stock price
Stock price
strike
strike

7. Transaction Costs (constant)
TCs lower your payoff curve
Profit & Loss
Stock price
short - TC
Profit & Loss TC
$10
long - TC
Stock price TC
$10

8. Transaction Costs (variable)
TCs always lower your payoff curve
Profit & Loss
Profit & Loss
long - TC
Stock price
Stock price TC TC
$10
$10
short - TC

9. WINIT
What Is New In Technology?

10. Most popular - included in the hmwk series
Hedging Strategies
Offsetting the position (not applicable to the HT)
One to one
One to many
Dynamic approaches
Delta hedging (based on Black Scholes)
Delta + Gamma hedging (complex refinement)
Synthetics (based on put/call parity)
Most popular - included in the hmwk series
Optional project
Optional project

11. Strategy #1: Offset the Position
Profit & Loss
Perfect hedge, but guaranteed to lose money because of TCs . Impossible do to when a position is illiquid (i.e., you cannot do it in the HT)
Short position
Long position to hedge
Stock price
Total Payoff
Can be done in HT with highly correlated securities, but highly imperfect hedge

12. Strategy #2 one on one (e.g., Covered Calls)
Profit & Losses
Very popular - Neutral to moderately bullish
long Stock
short call
strike
Total Payoff
Stock price

13. Example 1:1 Strategy Table
If our position is...
...this is what we (the system) should do
A short call
Go long on the stock
A long call
Go short on the stock
A short put
...
A long put
A short stock
A long stock
…works ok, but is expensive

14. Strategy #3: Multiple options (e.g., collars)
Profit & Losses
long Stock
Total Payoff
short call
long put
Stock price
Pick them way out of the money – Inexpensive means to protect wealth from sharp downturns

15. Strategy #4: Dynamic Approaches (e.g., “Stop Loss”)
Profit & Losses
long on Stock
Buy the stock if its price raises above strike, and sell it back if it falls below.
Total Payoff
Stock price
short call
Yes, there is a catch....

16. These were the Basics....
Typically useful for manually managing your portfolio - add a little extra
In the past:
Most teams did Delta Hedging
Some of the better teams did their own mix of Delta and Gamma hedging
There is a dark horse…

17. Demo
Homework