Hedging strategies Hedge (finance)

1 hedging strategies

1.1 back-to-back hedging
1.2 tracker hedging
1.3 delta hedging
1.4 risk reversal

hedging strategies

tracker hedging. fraction of open positions has within (grey-blue) hedging corridor @ every instance of time.

a hedging strategy refers general risk management policy of financially , physically trading firm how minimize risks. term hedging indicates, risk mitigation done using financial instruments, hedging strategy used commodity traders large energy companies, referring business model (including both financial , physical deals).

in order show difference between these strategies, let consider fictional company blackisgreen ltd trading coal buying commodity @ wholesale market , selling households in winter.

back-to-back hedging

back-to-back (b2b) strategy open position closed, e.g. buying respective commodity on spot market. technique applied in commodity market when customers’ price directly calculable visible forward energy prices @ point of customer sign-up.

if blackisgreen decides have b2b-strategy, buy exact amount of coal @ moment when household customer comes shop , signs contract. strategy minimizes many commodity risks, has drawback has large volume , liquidity risk, blackisgreen not know how whether can find enough coal on wholesale market fulfill need of households.

tracker hedging

tracker hedging pre-purchase approach, open position decreased closer maturity date comes.

if blackisgreen knows of consumers demand coal in winter heat house. strategy driven tracker mean blackisgreen buys e.g. half of expected coal volume in summer, quarter in autumn , remaining volume in winter. closer winter comes, better weather forecasts , therefore estimate, how coal demanded households in coming winter.

retail customers’ price influenced long-term wholesale price trends. hedging corridor around pre-defined tracker-curve allowed , fraction of open positions decreases maturity date comes closer.

delta hedging

delta-hedging mitigates financial risk of option hedging against price changes in underlying. called delta first derivative of option s value respect underlying instrument s price. performed in practice buying derivative inverse price movement. type of market neutral strategy.

only if blackisgreen chooses perform delta-hedging strategy, actual financial instruments come play hedging (in usual, stricter meaning).

risk reversal

risk reversal means simultaneously buying call option , selling put option. has effect of simulating being long on stock or commodity position.