How to Mitigate Risk with Delta Hedging and “Protective Collars”

Delta Hedging entails the continuous initiation of opposite integer delta positions so as to achieve delta neutrality. Thus, if a portfolio confers a high positive delta, the acquisition of negative delta instruments is instituted persistently to mitigate the price sensitivity to the underlying asset and vice versa (if negative, then positive), etc ad infinitum. Positive Delta Positions: Long Stock, Long Calls, Short Puts, Long Futures, Short CDS, Long Call Verticals, and Short Put Verticals. Negative Delta Positions: Short Stock, Long Puts, Short Calls, Short Futures, Long CDS, Short Call Verticals, and Long Put Verticals. Alternatively, if certain, optimistic, or bullish regarding a company’s future prospects, or a commodity’s potential demand, such as oil which began trading in contango on April 20 this year plummeting below a thirty seven year low into unprecedented negative territory, a “protective collar” may be adopted to minimize risk in the eventuality that said insight or intuition is fallible. This implies the acquisition of a ATM put with a strike price of the underlying security’s buy price and a long or short … OTM call whose strike price coincides with your anticipated future price range, and confers a premium exceeding or negating the cost of the put option; thus, insuring that the stock or commodity for example can be sold at the acquisition price with the nominal loss of the quotient of the sum of the put and call and initial share acquisition price. Therefore, if an individual possess knowledge or information contrary to that of the market, then they may acquire these derivatives quite inexpensively nullifying all potential downside in excess of negligible percent while retaining profitability if the share price appreciates beyond the OTM call option.