> Hedging is extremely odd in that while it is thought of as a way to lock in 'certainty' on the price of something, it really is just another way of gambling on a price.
Actually, yours is a rather odd take on the term 'certainity' itself! To clarify, I'll lay out the layman take & the quant take.
The layman explanation is - life is a gamble but I wear seatbelt. Because that's the certainity I won't die by being thrown off the seat. Yes, that might mean I might die in other ways. Like maybe the car dives into a lake & I couldn't get out because the seatbelt is stuck so I drown to death. But the car in lake probability is smaller than car collision probability. So I have purchased certainity in my mortal affairs by wearing the seatbelt. Atleast if my car collides with another car, I don't get thrown off for certain.
The quant problem is the same. My quant professor at UChicago always insisted "only losers buy stocks". He repeated that in so many ways that lesson stuck to all of us. Like, stocks are for losers. Quants don't buy stock, losers do. Now why did he take such a radical stand ? Stocks are a random variable so there is no certainity. That's the very definition of positive rv y(t), it can do anything on the positive y axis, because it is random. But you are not completely helpless. You can buy certainity on both the x & the y axis! And on functions of those if you are clever. So if you pay put premium on a 1 month expiry with say strike at 1 sigma, you are saying I am only willing to lose 1 sigma from my present mu within next month. If my stock falls below mu-1sigma, then some other loser better pay up. Who is that other loser ? The guy who sold me the put option. Because he holds the opposite belief, which is why he sold me the put. So I am certain I won't lose below 1 sigma. I have literally purchased my certainity by paying that put premium. The loser why sold me the put is also certain it won't go below 1 sigma, which is why he gets to collect my premium. Now, what will really happen ? Well, who the fuck knows. The stock is a random variable, so anything can happen. But neither of us have bought the stock. I have bought 1 certainity, the seller has sold another certainity. So its a win-win on the certainity axis. Because my max loss is capped at mu minus one sigma, I am certain of that. So even though underlying is random I am certain!
> No certainty has been gained. is really down to game theory.
This is simply not true. A lot of certainity has been gained, which is literally why money has been exchanged. Price of certainity is by definition the premium.
Show me where the certainty is, then! In all cases (being unhedged, hedging against rising, falling, stationary or volatile prices), the airline can still be adversely affected by the future oil price. Either directly, or through becoming unable to compete profitably with rivals who did not hedge.
Actually, yours is a rather odd take on the term 'certainity' itself! To clarify, I'll lay out the layman take & the quant take.
The layman explanation is - life is a gamble but I wear seatbelt. Because that's the certainity I won't die by being thrown off the seat. Yes, that might mean I might die in other ways. Like maybe the car dives into a lake & I couldn't get out because the seatbelt is stuck so I drown to death. But the car in lake probability is smaller than car collision probability. So I have purchased certainity in my mortal affairs by wearing the seatbelt. Atleast if my car collides with another car, I don't get thrown off for certain.
The quant problem is the same. My quant professor at UChicago always insisted "only losers buy stocks". He repeated that in so many ways that lesson stuck to all of us. Like, stocks are for losers. Quants don't buy stock, losers do. Now why did he take such a radical stand ? Stocks are a random variable so there is no certainity. That's the very definition of positive rv y(t), it can do anything on the positive y axis, because it is random. But you are not completely helpless. You can buy certainity on both the x & the y axis! And on functions of those if you are clever. So if you pay put premium on a 1 month expiry with say strike at 1 sigma, you are saying I am only willing to lose 1 sigma from my present mu within next month. If my stock falls below mu-1sigma, then some other loser better pay up. Who is that other loser ? The guy who sold me the put option. Because he holds the opposite belief, which is why he sold me the put. So I am certain I won't lose below 1 sigma. I have literally purchased my certainity by paying that put premium. The loser why sold me the put is also certain it won't go below 1 sigma, which is why he gets to collect my premium. Now, what will really happen ? Well, who the fuck knows. The stock is a random variable, so anything can happen. But neither of us have bought the stock. I have bought 1 certainity, the seller has sold another certainity. So its a win-win on the certainity axis. Because my max loss is capped at mu minus one sigma, I am certain of that. So even though underlying is random I am certain!
> No certainty has been gained. is really down to game theory.
This is simply not true. A lot of certainity has been gained, which is literally why money has been exchanged. Price of certainity is by definition the premium.