Hedging Contingent Claims

Abstract

In this chapter we will present a few simple examples that show what hedging is all about. In practice, understanding how to hedge risks is the single most important actor to become a good trader. In the general public traders, and in particular traders who are working with derivatives like options, are considered to be big risk takers [117, 31]. On some occasions, history has demonstrated that options can be tricky financial instruments that can introduce huge losses for the banks or institutions trading them [149, 117, 55]. However, the flexibility that these instruments bring to the investors or professional players in terms of reducing their risk cannot be denied [58, 52.]. Therefore, it is critical that both academics and practitioners develop a thorough understanding of both the theory, the market, the applications and the shortcomings or assumptions of the various models that are being deployed.