Buying Options as a hedge is usually expensive, costing much more than the risk they are to cover. This is because statistically, most of the markets tend to move within normally observed bounds of volatility, and only occasionally do they see a huge surge in volatility.

Thus, most of the times, the risk averse Option Buyer unwittingly bets on the small probability of a large move, while the Option Seller (the bank), in contrast, bets on the large probability of a small move. The Option cost PAID, when cumulated over a period of time, does not justify the few times that the market might have flared up. This is especially true when buying a plain vanilla option.


Even the case of an Importer buying a protective Call and selling a Call at a higher strike to reduce the cost, often turns out to be counterproductive if there is a large upmove in the Spot, because in that case the Sell Call also gets triggered leaving the exposure naked just when protection was needed.

The maths is even more discouraging for an Exporter who buys a protective Put. He firstly foregoes reeceiving the Forward Premium; and then on top of that he pays the Premium to buy a Put Option.




As part of the KSHITIJ Hedging Method, we have experimented with hedging with options and without options and have found that clearly, it has been much more profitable to hedge without options, as seen in the table above.





Read Previous
A natural hedge can lose you money

---