Explain the formula of hedging contract

Question

Explain the formula of hedging contract.

Answer 1

For illustration, if you want to utilize some out-of-the-money puts to make it worst case not so bad, after that you could optimize by choosing λ therefore the worst case of

F(δS) + λF^∗(δS) -|λ|C

shows an acceptable level of downside risk. Where F^∗(·)is the 'formula' for the change into value of the hedging contract, there C is the 'cost' related with each hedging contract and λ is the quantity of the contract that is to be determined. Practically there would be many more hedging contracts, not essentially just an out-of-the-money put, therefore you would sum over all of them and then optimize.