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Options Essence

The essence and its types. However, the so-called insurance mechanism exists, and is implemented through the futures exchange. This insurance mechanism is called Hedging.

The allure of real options is that they allow you to add a premium to traditional value estimates NPV, discounted cash flow value and override what are generally considered hard and fast rules in finance.

Hedging is an option for insuring assets against adverse price changes in the market, in which a trader buys an opportunity to buy and sell an asset futures in a subsequent period of time with fixed terms of the transaction. The name originates from the English hedge, which means insurance or protection.

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Hedging uses the futures market, which reduces the risks of an adverse trend change in this market, in fact, a futures transaction is a replacement for an upcoming transaction in the cash market, while the futures position has the opposite direction of the position in the cash market, thus reducing the risk. For example: The wheat producer is confident that its future crop will bring it profit in three months.

Provided that all farms get a good harvest, the price of wheat will decrease in the market. In this scenario, the buyer wins, but the manufacturer has insured itself. To avoid losing more.

When hedging, a fixed-term hedging contract is opened. The asset that is insured can be any asset from your portfolio and any asset that is only expected to be purchased. The the essence of the option is that where the possibility of operations with an asset is implemented is a spot market transactions in such a market are made immediately, usually within two days at most.

We can say that hedging contracts form a fixed-term or future market.

Hedge. The essence and its types.

Let's look at another example that examines the possibility of compensating losses from the sale of an asset by selling futures and Vice versa: Let the organization acquire a tanker with oil, having a desire for subsequent resale. In the current period of time, it is not able to sell oil at current market prices, however, the organization sells a futures contract for oil.

In the subsequent period, the organization sells oil and buys futures. Thus, the loss is compensated in one market at the expense of profit in another, we can say this is comparable to an arbitration operation.

Понятно, почему она не хотела верить ни одному его слову. Он почувствовал, как вокруг него выросла стена, и понял, что ему не удастся выпутаться из этой ситуации, по крайней мере своевременно. И он в отчаянии прошептал ей на ухо: - Сьюзан… Стратмор убил Чатрукьяна. - Отпусти ее, - спокойно сказал Стратмор.  - Она тебе все равно не поверит.

Such operations are possible because of the close relationship between the price on the real market and the futures market. Of course, we can not say that the prices in both markets are the same, since there are differences.

For this reason, it is impossible to talk about an ideal hedge, in which losses are reduced to zero, but at the same time, the importance and possibilities of hedging are fully justified when trading.

Successful hedging depends on the degree of correlation of prices in the cash and futures markets, the higher the correlation, the more successful the hedging.

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Of course, there is a risk that changes in prices on the cash market will not be compensated by changes in prices on the futures market, which will result in a loss or profit. But this is how hedging protects the underlying risk from the greater risk caused by the insecurity of an open position in the cash market.

A market participant who insures their risk is called a hedger, and the counterparty in the hedging contract may be: - hedger's partner; - other hedger buyer or seller of the underlying asset, which also insures the risk, but in the opposite direction ; - financial speculator.

The hedging strategy for participants is based on a unidirectional parallel change: - current price of the underlying asset-spot prices; - a prospective "futures" price. Operation of the hedge opens two trades at the same time: - transactions with the underlying asset on the spot market; - transactions the essence of the option is that the futures market of the same asset.

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Hedging can be of various types, let's look at what types are: By the type of instruments used in hedging: - Exchange-traded instruments futures, optionswhile contracts are opened exclusively on exchanges, and transactions have a third party-a Settlement Fee that tracks the performance of obligations. It is worth highlighting the following positive aspects of such hedging: - security, - market liquidity.

The disadvantages are standardized assets, strict requirements, and various restrictions on transactions. Positive aspect: - Large flexibility in the choice of an asset and the terms of the contract. The disadvantages of such hedging are low liquidity with an increased risk of default, and increased transaction costs.

The next type is hedging by type of counterparty. It is divided into the following types: - The buyer's hedge, in this case, the buyer's risks are insured, which are associated with a prospective increase in prices and deterioration of the transaction conditions.

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With such hedging, the most common operations are the purchase of forwards, futures, call options, as well as the sale of put options. This hedging involves selling forwards, futures, and call options, as well as buying put options. Hedge by the amount of risk that must be insured, is divided into the following types: - Full hedging, in which the entire volume of the transaction is insured.

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By the time the underlying transaction is concluded, the hedging is divided into: - Classic hedging, used with the application of a fixed-term transaction, which is concluded after the transaction with the insured asset.

Hedging by asset type is divided into: - Net hedging, in which the insurance contract is concluded for the same type of asset. Hedging under the terms of the contract is divided into: - One-sided hedging, in which the possible loss from price changes in the market is fully borne by one of the participants in the transaction — the buyer or seller. It is worth noting that all the types of hedging analyzed allow you to choose the most optimal strategy for the implementation of the trading mechanism.

Of course, it is worth saying that this type of operation is quite difficult for a beginner, and sometimes for an experienced user, it causes a large number of problems.

Session 22: The Essence of real options

Today, the use of this type of operations is facilitated by implementing hedging mechanisms in various trading systems and robots. For example, StockSharp has implemented an "Hourglass" trading robot that allows hedging using various methods and trading operations. For Designer users, the "Hedging" cube is implemented, which settings allow you to protect against risks in ongoing trading operations.

In this way, where to make money a lot strategies is easier, and is reduced to configuring the cube and input parameters.

Remember that the types of hedging considered can be fully implemented using our SOFTWARE, including the implementation of these methods is considered in the course of programming training. The most important thing is to remember and not forget about the opportunities to save your profit, and hedging methods will come in handy Tags:.