Hedging and Investment Strategies Flashcards
Hedging
Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.
Non-Diversifiable Risk
The risk inherent to the entire market or an entire market segment. Systematic risk, also known as “undiversifiable risk,” “volatility” or “market risk,” affects the overall market, not just a particular stock or industry. This type of risk is both unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the right asset allocation strategy.
Diversifiable Risk
Company- or industry-specific hazard that is inherent in each investment. Unsystematic risk, also known as “nonsystematic risk,” “specific risk,” “diversifiable risk” or “residual risk,” can be reduced through diversification. By owning stocks in different companies and in different industries, as well as by owning other types of securities such as Treasuries and municipal securities, investors will be less affected by an event or decision that has a strong impact on one company, industry or investment type. Examples of unsystematic risk include a new competitor, a regulatory change, a management change and a product recall.
bull spread
Long Call (k1) + Short Call (k2) K1
bear spread
Short Call (k1) + Long Call (k2) K1
Short Synthetic Forward
Long Put + Short Call
Long Synthetic Forward
Short Put + Long Call
Collar
Long Put + Short Call
The effect is a collar around a certain price, but if the stock moves quite a bit down then you make money and if it moves up then you lose money.
Insurance on stock
Strangle
Long Put + Long Call , but the strike prices differ
You make money whether the stock moves right or left.
Straddle
Long Put + Long Call and the strike prices are the same.
Written Straddle
Short Put + Short Call, basically betting against any change in the stock price.
Collar Width
The difference between the strike prices of the two options in a collar.
Collared Stock
A collar provide insurance on a stock. If the price goes down then the collar provides the difference and if the price goes up then the you lose some if it goes above the short call.
zero-cost collar
A collar whose premium on the long put is offset by the premium received by the premium short call.
ratio spread
Long and short call and puts, so there is little payment and if the stock moves only a little up, then you get money, else you end up losing money on the deal and it can be a lot of money because you are holding multiple short positions.
An options strategy in which an investor simultaneously holds an unequal number of long and short positions. A commonly used ratio is two short options for every option purchased.
