It is clearly evident from the ranking table that the most suitable hedging strategy in terms of riskiness is the delta hedging strategy using the put options. There are basically two cases, one of stable dollar and strong dollar. First of all in the case of the stable dollar case, it could be seen that the forward contract loses the money. As it has been discussed by John H. (2013), the purchase cost of a put option is very high and as a result this strategy fails. In this case the opening spot rate conversion and the delta hedging is almost similar for hedging the exposure which is also the motive of this strategy as described by Longo J. (2009).
In addition, as the exchange rate is moving around the pegged value, a higher value is being paid under the uncovered strategy. In the second case of strong dollar scenario, if a forward position is taken on the entire portfolio then it would be the best strategy because of the reason that dollar is going to be strong. Moreover, a big sum of money is being lost by the uncovered and the put option cover and the same situation could also be seen in the scenarios 3 and 4.
Riskiness of Delta Hedging
As seen previously in the ranking table, the delta hedging strategy is ranked as 2nd in all of the 4 cases, which makes this as the most suitable hedging strategy for the company. As given in the case, out of the 4 scenarios three scenarios were to be of strong dollar and one scenario had to be of a stable dollar. Some of the justifications for using delta hedging are as follows:
Similarity of Delta hedging to Forward Contracts: Forward covered options are being used by Delta hedging, which is basically a linear hedging as discussed at the options trading tips. As discussed by Giovanni B. (June, 1987), the delta hedging strategy clearly tells the amount of the exposure which should be covered in order to make the risk equal to 0 for the portfolio. The delta calculated in this case is based on this basic model of Black and Scholes for valuing options. A part is decided by delta and the other part is covered using forward cover.
Continuous Update of Delta:In this case, the delta is continentally updated and the updating is done with regard to the changes in the spot exchange rates. For each of the new delta value, this portfolio no longer is considered as a risk free portfolio. Change needs to be introduced to the value of the forward cover and the value of the delta needs to be updated continuously. This results in a dynamic hedging through the delta and as a result of this the performance of the entire portfolio is increased. The delta of the portfolio is updated on a daily basis in order to achieve the best results possible. This same strategy has also been described in the book Derivative and Risk management by Rajiv S. (2014).
Minimal Hedging Cost:As the delta hedging shows the most optimal value for the hedging which is required in order to create a risk free portfolio. In this way, the cost of hedging is minimized and the delta hedging strategy proves to be a better strategy as compared to the put option cover buying or as compared to the standard forward contract hedging strategy for the complete portfolio value.
Flexibility:Delta hedging proves to be a reasonable strategy for all the hedger because the flexibility provided by this strategy is quite high and the hedgers consider all the losses, which occur as a result of this strategy as reasonable because of the high level of flexibility offered by this strategy………………..
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