basis risk, options risk, structure risk, and repricing risk.

Understanding Basis Risk

Offsetting vehicles are generally similar in structure to the investments

being hedged, but they are still different enough to cause concern. For
example, in the attempt to hedge against a two-year bond with the
purchase of Treasury bill futures, there is a risk the Treasury bill and the
bond will not fluctuate identically.

To quantify the amount of the basis risk, an investor simply needs to take
the current market price of the asset being hedged and subtract the
futures price of the contract.

For example, if the price of oil is $55 per barrel and the future
contract being used to hedge this position is priced at $54.98, the basis is
$0.02. When large quantities of shares or contracts are involved in a
trade, the total dollar amount, in gains or losses, from basis risk can have
a significant impact.

 Basis risk is the potential risk that arises from mismatches in a

hedged position.
 Basis risk occurs when a hedge is imperfect, so that losses in an
investment are not exactly offset by the hedge.
 Certain investments do not have good hedging instruments,
making basis risk more of a concern than with others assets.
What Is an Option?

The term option refers to a financial instrument that is based on the

value of underlying securities such as stocks. An options contract offers
the buyer the opportunity to buy or sell—depending on the type of
contract they hold—the underlying asset. Unlike futures, the holder is
not required to buy or sell the asset if they decide against it. Each
contract will have a specific expiration date by which the holder must
exercise their option. The stated price on an option is known as the strike
price. Options are typically bought and sold through online or retail
brokers.

 Options are financial derivatives that give buyers the right, but not
the obligation, to buy or sell an underlying asset at an agreed-upon
price and date.
 Call options and put options form the basis for a wide range of
option strategies designed for hedging, income, or speculation.
 Although there are many opportunities to profit with options,
investors should carefully weigh the risks

Understanding Options

Options are versatile financial products. These contracts involve a buyer

and seller, where the buyer pays a premium for the rights granted by the
contract. Call options allow the holder to buy the asset at a stated price
within a specific timeframe. Put options, on the other hand, allow the
holder to sell the asset at a stated price within a specific timeframe. Each
call option has a bullish buyer and a bearish seller while put options have
a bearish buyer and a bullish seller.

Traders and investors buy and sell options for several reasons. Options

speculation allows a trader to hold a leveraged position in an asset at a
lower cost than buying shares of the asset. Investors use options
to hedge or reduce the risk exposure of their portfolios.

In some cases, the option holder can generate income when they buy call
options or become an options writer. Options are also one of the most
direct ways to invest in oil. For options traders, an option's daily
trading volume and open interest are the two key numbers to watch in
order to make the most well-informed investment decisions.

American options can be exercised any time before the expiration date

of the option, while European options can only be exercised on the
expiration date or the exercise date. Exercising means utilizing the right
to buy or sell the underlying security.

Options Spreads
Options spreads are strategies that use various combinations of buying
and selling different options for the desired risk-return profile. Spreads
are constructed using vanilla options, and can take advantage of various
scenarios such as high- or low-volatility environments, up- or down-
moves, or anything in-between

Structural risk refers to the financial structure of the investment and the
rights that the structure provides to the individual participants.

Repricing risk is the risk of changes in interest rate charged (earned) at

the time a financial contract's rate is reset. It emerges if interest rates
are settled on liabilities for periods which differ from those on offsetting
assets. Repricing risk also refers to the probability that the yield curve will
move in a way that influence by the values of securities tied to interest
rates -- especially, bonds and market securities.
Repricing risk is presented by assets and liabilities that reprice at different
times and rates. The changes in interest rate either impacts on the asset
returns or the liability costs. Repricing risks arise from timing differences
in the maturity for fixed-rate and repricing for floating-rate bank assets,
liabilities and off-balance-sheet positions. Any instance of an interest rate
being reset—either due to maturities or floating interest rate resets—is
called a repricing. The date on which it occurs is called the repricing date.
One reason may be maturity mismatches. For instance, suppose a
company is earning 5% on an asset supporting a liability on which it is
paying 3.5%. The asset matures in three years while the liability matures
in ten. In three years, the firm will have to reinvest the proceeds from the
asset. If interest rates decrease, it could end up reinvesting at 3%. For the
remaining seven years, it would earn 3% on the new asset while
continuing to pay 3.5% on the original liability. Repricing risk also occurs
with floating rate assets or liabilities. If fixed rate assets are financed with
floating rate liabilities, the rate payable on the liabilities may rise while
the rate earned on the assets remains constant.
If a portfolio has assets repricing earlier than liabilities, it is said to be
asset sensitive. This is because recent changes in earnings are driven by
interest rate resets on those assets. Similarly, if liabilities reprice earlier,
earnings are more exposed to interest rate resets on those liability, and
the portfolio is called liability sensitive.