IC 301
IC 301
Seminar 3
Hedging, speculation, arbitrage…
Hedging Speculation Arbitrage
Purpose To minimize risks; a position in derivatives can be used to offset the exposure To increase profits, no position to offset, a bet on future price movements, short-term risky strategy betting on market inefficiencies, taking positions in different markets to ‘lock in profit’, risk is limited
Example Hedging a long position with a short futures contract
Buying a security with a hope that the price will go up Buying an undervalued asset
Riskiness Minimal Very risky Limited
Long Call = ‘buy a right to buy at today’s price on a future date’
Payoff:
Long Put= ‘buy a right to sell at today’s price on a future date’
Payoff:
Short Call = ‘sell a right to buy at today’s price on a future date’
Payoff:
Short Put = ‘sell a right to sell at today’s price on a future date’
Payoff:
Moneyness
Out-of-the-money: OTM
S
At-the-money: ATM
S=K for calls and puts
In-the-money: ITM
S>K for a call, S