Risk Management [1] if You Believe a Term Paper

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Risk Management [1]

If you believe a stock will appreciate and want to risk little to speculate that the stock will rise what are your option?

Holding a call option is fairly low risk because it would allow me to buy future stocks at a current price. An increase in stock value would limit my losses and allow me to profit by means of leveraged speculation. As a holder exercising a call option, I would be able to benefit from the same profit in underlying stock by paying only a minimal amount of money. By risking only a small percentage of my capital towards an insurance premium, I am potentially able to benefit from trends and hedge away risks within the call-option deadline.

Potential losses can be offset against either long-or-short stock portfolios by means of trading call strategies. A Fiduciary call would allow for a reduced capital outlay by means of replacing stock with a corresponding amount of call options, which would shield stock from losses beyond strike price. A Bull Call Spread would take advantage of moderate underlying stock risings by using short call options as a means to cover long call options. Similarly, a Calendar Call Spread would enable me to profit from stagnant or moderate-rising stock by writing or buying call options of different expiration dates. Finally, Stock Replacement -- a strategy based on studied hedging and Deep in the Money call options, would allow for higher profit while reducing risk and volatility.

2. If I can simultaneously 'Buy a call and Sell a put' to the same underlying asset, with each option having the same strike price and time to expiration have I created a synthetic forward? That is, the price premium of buying the call is the same as the premium I will get for writing the put for the same underlying asset.

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This would have the effect of allowing me to take control or own the asset for nothing. Can this be accomplished? Why or why not?

Simultaneously buying a call and selling a put will neutralize the resulting premium balance, although a net option premium would still have to be paid. Synthetic Forward Contracts are risk-reducing investment strategies, though further strategies should still be implemented in order to counteract potential losses. Likewise, a short trigger option would enable me to create a Synthetic Forward Contract in order to hedge a long position, by simultaneously selling a put struck below the original put being sold. Similarly, an at-maturity trigger forward would be nulled if a pre-determined trigger level is breached by the Synthetic Forward's expiration date.

3. Why would a manufacturer elect to use a long call strategy instead of a forward contract to hedge the risk associated with variable costs?

Most forward contracts are not listed on a stock exchange, since they establish the delivery of a future product only after a contract has been made. Prices are locked in a future contract, whereas a long call option allows for a more profitable outcome because it is an investment based on the underlying number of stock shares purchased, as opposed to the specific amount of the initial investment. While holding a long call option, a manufacturer retains the right to purchase at any time an equivalent number of underlying shares at the predetermined strike….....

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