Page 163 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management Dilfraz Singh, Lovely Professional University

Notes Unit 12: Risk Management with Derivatives I

CONTENTS
Objectives
Introduction

12.1 Hedging using Greeks (Delta-Gamma Hedging)
12.1.1 Delta of an Option

12.1.2 Option Gamma
12.1.3 Option Vega
12.1.4 Rho and Phi

12.2 Hedging with Futures
12.3 Strategies of Hedging

12.4 Speculation and Arbitrage
12.4.1 Speculation using Future Contracts
12.4.2 Arbitrage using Futures

12.5 Summary
12.6 Keywords
12.7 Review Questions

12.8 Further Readings
Objectives

After studying this unit, you will be able to:
 Describe hedging using Greeks (Delta-Gamma hedging)

 Explain hedging with futures
 Describe strategies of hedging
 State the benefits of speculation and arbitrage in futures

Introduction

The dictionary meaning of risk is the possibility of loss or injury; the degree or probability of
such loss. In risk, the probable outcomes of all the possible events are listed. Once the events are
listed subjectively, the derived probabilities can be assigned to the entire possible events. For
example, the investor can analyse and find out the possible range of returns from his investments.
He can assign some subjective probability to his returns, such as 50% of the time there is a
likelihood of getting ` 2 per share as dividend and 50 % of the time the possible dividend may
be ` 3 per share. Often risk is inter-changeably used with uncertainty. In uncertainty, the possible
events and probabilities of their occurrence are not known. Hence, risk and uncertainty are
different from each other.

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