Hedging choices

This was a question in another thread. Hedging choice can have a massive effect on some desks, less on others. It's related to product and by extension liquidity.

There are desks for which the hedging choice is clear and readily available. Something like FX spot is a clear example....the markets are global, continuous, and almost always liquid. The trading risk is mostly related to getting stuck with a large position and choosing an orderly way of hedging.

Then there are intermediate products, something like equity options....the markets are open for defined hours, but they specific hedge you need might not be readily available, and certainly not in the right size. So maybe you hedge with a different strike or expiry, but in the same underlying, or in a related underlying.

Then there are the true exotics, where a real hedge may not exist, or may not be even remotely liquid. So you do the best you can, try to make a smart price at the outset and then sit with gigantic correlation and basis positions. Choice of hedge is critical for these products and a major p&l driver.

 

As Jimbo was saying about equity options, client trades are going to involved OTC options, whereas the hedging of these transactions could use exchange traded options, another OTC option or a position in the underyling. The determination of which one depends on a desk's risk appetite (you can trade price risk for counterparty risk for basis risk) and the ability to get funding to maintain a position

 

That sounds about right for equities...now imagine if you were unable to access the underlying...so you've traded say a bunch of otm google options for a custie, but you cant trade anything GOOG against it to hedge. furthermore you don't even have any markets in other web or computer companies as proxies, and the one US based company you can trade has an illiquid underlying and only a few atm options quoted, but in the wrong tenor, and with absurdly wide markets.

And presto, welcome to my world.

 
girlytrader:
Can someone give me an example of how VaR is calculated or a suggestion of where I can find this...Also, in fixed income how does VaR and Jump to Default calculations differ??

http://riskglossary.com/

In my previous risk mgmt. role, I used the above link to learn all the preliminary fluff.

 

most schools should have courses on derivatives, no? that's where u can probably pick up the greeks. I think it varies from school to school, but for VaR you may have to get yourself enrolled in another course, probably something like risk management.

If you don't want to get yourself involved in those courses, John Hull's book is a pretty good starting point.

What Jimbo is doing, of course, is much more interesting than the textbooks.

Jimbo: Just wondering, how much freedom do you have on the choice on the hedge since a real hedge doesn't exist?

 

"Jimbo: Just wondering, how much freedom do you have on the choice on the hedge since a real hedge doesn't exist?

"

Well that's pretty much our job...so until you start bleeding cash, all the choice in the world :)

 

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