FBE459_3_6_Hedging_Options

FBE459_3_6_Hedging_Options - FBE 459 Financial Derivatives...

Info iconThis preview shows pages 1–12. Sign up to view the full content.

View Full Document Right Arrow Icon
FBE 459 – Financial Derivatives Prof. Pedro Matos Lecture 3.6.: Hedging Options Portfolio insurance Delta-hedging Greeks Readings: HULL chapter 17
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
2 Lecture Outline Portfolio insurance Delta-hedging Greeks
Background image of page 2
3 Portfolio Insurance Examples: A mutual fund manager owns a portfolio of stocks which he wants to protect against a fall in prices. • A pension fund manager wants to make sure his assets will exceed his liabilities in spite of interest rate and stock price changes.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
4 Portfolio Insurance 1. Static portfolio insurance: > Hold stocks and buy put option on index [ S + p ]. S T K S T K S T K + = LONG STOCK LONG PUT PROTECTIVE PUT
Background image of page 4
5 Portfolio Insurance 2. Dynamic portfolio insurance: > Dynamically rebalance the portfolio of stocks and T- bonds to replicate a put option on the portfolio. How to replicate S + p ? S + p = S + Ke -rT N(-d2 ) - SN (- d1 ) = S (1 - N(-d1)) + Ke -rT N(-d2 ) = S N ( d1 ) + Ke -rT N ( -d2 ) $ invested in T-bonds $ invested in stocks
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
6 Portfolio Insurance 2. Dynamic portfolio insurance: > Dynamically rebalance the portfolio of stocks and T- bonds to replicate a put option on the portfolio. • When the market rises, sell T-bonds to purchase stocks • When the market falls, sell stocks to buy T-bonds
Background image of page 6
7 Portfolio Insurance 2. Dynamic portfolio insurance: > Remember: works only for small changes in S ! > Requires frequent rebalancing, which implies higher transaction costs !
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
8 Portfolio Insurance 2. Dynamic portfolio insurance: > When can portfolio insurance go wrong? -> Debate over whether portfolio insurance caused the 1987 crash: read Rubinstein_1987Crash.pdf !
Background image of page 8
9 Portfolio Insurance: Application Structuring an Equity-Linked Note: > Motivation: retail investors want a share of stock market gains but want their capital protected > An equity-linked note (ELN) is a contract that pays a guaranteed minimum return plus a proportion of the appreciation in an underlying stock or stock index
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
10 Portfolio Insurance: Application Structuring an Equity-Linked Note: – Underlying stock or stock index, S – Principal amount, P – Guaranteed return, g – Participation in equity gains if the underlying rises, x – Maturity, T
Background image of page 10
11 Portfolio Insurance: Application Structuring an Equity-Linked Note: . How to “synthethise” this for your client:
Background image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 12
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 04/20/2011 for the course FBE 459 taught by Professor Matos during the Spring '08 term at USC.

Page1 / 40

FBE459_3_6_Hedging_Options - FBE 459 Financial Derivatives...

This preview shows document pages 1 - 12. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online