Hedging strategies

bowlhead99

There are two main ways to lock in profit on an appreciated asset.

One is simply to dump the assets in favour of what is going to stay flat or relatively go up more. In the dotcom bubble-busting of 2000 for example, a lot of hedge funds which had been long IT shares sold off their IT long positions in mid-2000, but didn't necessarily take up short ones, simply moving to cash or other sectors. This helped the hedge index to fare much better than the broad share indices.

The other obvious way to hedge against an asset going down is to broadly match your long positions with short positions in that asset or those with similar characteristics. Of course, this doesn't work if the SEC imposes a ban on short selling of financial stocks as it did for a period in 2008. If you were a fund with a short strategy or at least a short-biased strategy, you were kinda screwed. That would also hit market-neutral strategies such as convertible arb or fixed income arb, to the extent they needed to be able to short to make the strategy work. Arguably the ban on shorting didn't do much to arrest the fall of financial stocks but it certainly increased trading costs and lowered liquidity.

There are a whole bunch of reasons why some hedge funds failed in the last credit crunch/ financial crisis and in other crises before and after it. Overleverage and lack of liquidity in the underlying market at times when investors wanted to exit, would be a big factor. But SEC action to try to stop you hedging, when you wanted to hedge, would also be up there.

Overall though, I agree with the good answers you got in posts #2,4,5. There is no point just looking up an answer if you don't understand something, because it won't help you pass an exam which bans wifi or which doesn't give you a day for online collaborators to give you feedback for you to incorporate into an answer.

One recommendation is that if you do lift any ideas from this or other forums, make sure you type them really quickly - without thinking to go back and check the spelling or grammar/ sentence construction. Otherwise there is a risk that it will stand out from your usual written style.

bowlhead99

IronWolf wrote: »

Price is determined by a couple of Nobel prize winners...

Sorry, but I'm calling B.S. on that!

student882

Very, very helpful! I am still first year of my education and I agree I am still a newbie in most of the matter but I have a great desire to learn. For me it's not just "passing AN exam"! I did a lot of research and most of what you replied were to some degree my conclusions too (ofcourse you have far better knowledge than me). Maybe I still lack confidence and was affraid that I will sound FUNNY to a prof. community if I directly write the answers I might think are correct. Anyway generaly buying/selling of long/short positions of negative corelated derivates was my answer to the hedging question. You just made it crystal clear in further details! Thank you!!!

I am really glad that I stumble upon a nice community willing to help people who want to learn!

IronWolf

Have you learnt about Options and Black-Scholes?