: The systematic deployment of offsetting positions, often using futures or options, to neutralize specific portfolio risks such as delta or vega exposure. Effective hedging requires precise measurement of the risk factor sensitivity. Prudent traders continuously monitor hedge effectiveness.
Mitigation
: This involves proactive steps to reduce the probability or impact of adverse outcomes, such as setting stop-loss triggers or reducing leverage during periods of elevated market uncertainty. For derivatives, this often means purchasing protection against tail events. Successful mitigation preserves capital through market dislocations.
Control
: Establishing clear limits on maximum allowable exposure to specific risk factors is a fundamental element of governance. Maintaining strict adherence to these control parameters prevents catastrophic drawdowns. Oversight ensures that trading activity remains within the firm’s defined risk appetite.
