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4.1  Overview


his chapter describes one of the major uses of option pricing theory: risk management.  You will learn how to control the price risk of a stock position or an option position.  In  topic 4.2 The Economics of Re-trading, you will learn about two theoretically equivalent ways to control risk.  The first is by using a portfolio of securities, and the second is through what is called dynamic rebalancing.  Rebalancing is similar to creating a synthetic option, and typically it requires fewer securities and more trading than the first method.  We take advantage of this equivalence in  topic 4.3, Delta Hedging.  Finally, we work through an actual risk management exercise in topic 4.4, Portfolio Insurance Problem.