Discuss the three methods used to reduce the risk of extreme price moves.Ask the class to also elaborate on why simple delta hedging is inadequate to the task.

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The Answer is The three methods used to reduce the risk of extreme price moves are diversification, hedging, and using stop-loss orders.

Diversification involves spreading investments across different assets or asset classes to reduce the impact of a single investment's performance on the overall portfolio. By diversifying, investors can lower the risk of extreme price moves in any one particular investment.

Hedging involves taking a position in a financial instrument that is negatively correlated with the asset being hedged. This can help offset potential losses in the original investment if the price moves in an unexpected direction.

Stop-loss orders are used to automatically sell a security when it reaches a certain price, limiting the potential losses on an investment. This can help protect against extreme price moves by setting a predetermined point at which to exit a position.

Simple delta hedging, while a useful tool for managing risk in options trading, is inadequate to the task of reducing the risk of extreme price moves because it only considers the change in the price of the underlying asset. It does not take into account other factors that can contribute to extreme price moves, such as market volatility, interest rates, or geopolitical events. As a result, it may not provide sufficient protection against sudden and significant price fluctuations. Therefore, while delta hedging can be a valuable component of a risk management strategy, it should be used in conjunction with other methods to effectively reduce the risk of extreme price moves.

Discuss the Three Methods Used to Reduce the Risk of Extreme