If i own 100 shares and buy a put for a little above market value, this is hedging my risk correct?
IF the stock drops considerably i can sell my 100 shares at the put price (or just sell the put)
or if the stock goes up considerably i can not exercise the put and sell it at market value
is my logic correct?
Kinda.
It is hedging your risk against a big downturn, but...
what happens if the stock goes 6 months and is exactly the same price you bought? You lose the put (the price didn't change and the time value decreases as you get closer to expiration). You also didn't get any price appreciation...
This is a good strategy if the stock goes up a lot or goes down a lot, but is a loser if it doesn't move.
good luck!
Financial Markets (ECON 252) Statistics and mathematics underlie the theories of finance. Probability Theory and various distribution types are ...
How is this both positive and negative?
The dog is cute, but hedging is not exclusive to managing risk against future cost increases.
Hedging can also be applied to protect downside risk.
Hedging can be used many other ways. One could use options, futures, short selling, and other methods to mitigate risk.
Example:
Position: You're long oil.
Concern: Near term down side risk.
Possible Solution: Buy put options on oil to hedge risk of short term price fluctuations in the negative.
Example 2:
Business: Airlines
Biggest Expense: Jet Fuel
Concern: Rising cost of jet fuel.
Possible Solution: Buy call options, or futures contracts on jet fuel to have the right to buy jet fuel at today's prices.
Example 3:
Business: Fund Management
Position: You're long the Dow 30 or most of the stocks in the S&P 500 and own them outright.
Concern: near term falling prices.
Possible Solution: Buy put options on the S&P 500 to mitigate near term downside risk.
There are many other ways to hedge, including more complex methods such as using futures, currencies, and other derivative contracts including but not limited to credit default swaps (CDO's).
There is always a cost to the hedge which must be factored in the cost benefit analysis. The bigger the position to be protected, the bigger the cost of the hedge. You have to consider, how much "insurance" (cost of hedge) do I want to pay to protect my position?
Hedging is merely a difficult, smart word for avoiding risk. hedging the risks of global warming on a whole would be to buy a bigger air conditioner (haha). In an investment standpoint, the reference is most likely to avoid losing money stemmed from these problems. with more money being invested in "green" companies, that means dividends received from owning stock in less-green companies will likely drop.
to hedge, (avoid the risk of losing that money) one would invest in scattered green companies, and other renewable energy researchers. This could also mean government protocols to ban using aerosol cans or producing diesel trucks. just remember, the words are complex, the statement is simple. they intend to avoid being harmed from the problem of global warming. Hope this helped!
Let’s say the airline company fully hedges its oil exposure by buying oil futures at €90. What is its potential expenditure (per barrel of oil) if oil is €70, €80, €90, €100 or €110? Illustrate your answer using a payoff diagram for each future contract as well as the hedged expenditure per barrel of oil.
You will pay the price of a barrrel of oil today + interest for the time period. Also an adjustment for whether the expectation is for oil prices to go up or down over the length of the contract. Just compare the cash price for oil against the different futures (Dec, Jan, Feb etc.). Don't forget to compare the same type of oil. (Brent, West Texas etc.)
Insurance companies do not always make profits. In fact, insurers lost over $40 billion after Katrina. Many insurers went out of business or stopped their earthquake coverage after the 1991 Northridge earthquake.
Over the long term, the total premiums and fees that insurers collect usually exceeds their payouts. They hire mathemeticians to statistically analyze the probabilities of accidents occurring and then set their premiums to a level that covers the expected losses that they cover.
Where insurers really make their money is not on their premiums. They are not allowed to spend most of this money. Instead, they must keep it in reserve to cover possible payouts.
Insurers earn their money on the interest from their cash reserves. For example, if an insurer collects $150 million in premiums during a year and pays out $100 million to cover insured losses and operating costs. The insurer will have $50 million left over, most of which must be kept in a cash reserve. Assuming the insurance company can earn 10% interest from investing this cash, it would earn a $5 million profit.
Over time, the cash reserves of insurance companies grows. Eventually, very large insurance companies can have many billions of dollars in reserve. They spread their risk across many customers and earn lots of money from investing their enormous reserves.
Two years ago, when he spoke at the Value Investing Congress, David Einhorn said Lehman was in unfathomable suffering . Turned out it was a movables call. Today he gave another keynote at the seminar in which he argued the policies of the delivery have put us on a very threatening plan, one which has encouraged him to buy manifest gold as security against sultan negligence(s).
Here’s a pdf of the sales pitch . A few highlights below.
On Bernanke and Geithner:
Presently, Ben Bernanke and Tim Geithner have become the quintessential brief-sitting resolution makers. They explicitly “do whatever it takes” to “decipher one question at a continuously” and administer with the unintended consequences later. It is too straight away for narration to quantify their vocation, because there hasn’t been every now for the unintended consequences of the “do whatever it takes” conclusiveness-making to become an actuality.
The normal way to distribute with too-big-to-be unsuccessful, or too inter-connected to abort, is to provoke definite that no sanatorium is too big or inter-connected to neglect. The exam ought to be that no founding should ever be of one concern such that if we were faced with its demise the control would be calculated to butt in. The genuine d is to hiatus up anything that fails that check-up.
The assignment of Lehman should not be that the regulation should have prevented its deterioration. The maxim of Lehman should be that Lehman should not have existed at a proportion that allowed it to risk the monetary system. And the same sound judgement applies to AIG, Fannie, Freddie, Hold up Stearns, Citigroup and a yoke dozen others.
The regulation talks stout about TBTF, but has made very determined they aren’t consenting to upon conduct choices to do anything to proactively get through a disband them up. It was very important when, in a keynote at the Economist’s Buttonwood Conclave, Larry Summers said too-big-to-go into receivership means too-big-not-to-be-regulated. The befitting aspect to have said, the faultless system that needs to be worked out so that we escape a re-run of last year’s danger is “too big to abandon is too big to abide.” But don’t take my tete- for it, take Alan Greenspan’s .
...Business Line - Oct 25, 2009
The policy should spell out the roles and responsibilities of business units and functions and define an easily understood risk management and hedging
InvestmentNews - Oct 25, 2009
But for the average investor who is trying to diversify his or her portfolio and looking to hedge the risk, there are other ways to do it. and more »Bloomberg - Oct 23, 2009
“Heavy hedging activity” accounts for the wider gap, according to a report yesterday from McMillan Analysis Corp.'s Option Strategist Hotline. and more »Wall Street Journal - Oct 22, 2009
CBC.caRochdale Analyst Bove Downgrades Wells Fargo >WFC"If you take a close look at the earnings, what you can see is that the improvement is due to a hedging profit made on the mortgage service portfolio, Wells Fargo & Company Q3 2009 Earnings Call TranscriptCOLUMN-Wells farrago: Rolfe WinklerWachovia savings boost Wells profits - -all 1,706 news articles »
MarketWatch - Oct 15, 2009
Times LIVE amount of derivatives to trade them on an exchange unless they are exempted small businesses end-users hedging commercial risk on commercial businesses. House Panel Approves Derivatives Regulation BillBeware Of New Regulation Of DerivativesPanel Vote Is First Test of Proposed Reg Revamp - -all 892 news articles »
Hedge (finance) - Wikipedia, the free encyclopedia
Risk reversal: Simultaneously buying a call option and selling a put option. ... Futures contracts and forward contracts are means of hedging against the risk of adverse ...