Right Tail Hedging: Managing Risk When Markets Melt Up
Posted: 15 Feb 2018
Date Written: February 3, 2018
Popular academic and practitioner lore claims that buying options, whether puts or calls, is a negative expected return investment and hence should not be undertaken by “rational, risk-neutral” investors. However, real world considerations such as the possibility of large jumps and imitative behavior of traders in both bull and bear markets can reverse this conclusion. In particular, the potential for positive economic shocks such as those observed since the 2016 US election may make call options based strategies superior to buy and hold strategies. In this article, the author extends work published in 2007 in the journal on left tail or downside tail risk hedging to “upside” hedging, whose importance has become increasingly relevant in an environment of low yields, elevated asset prices, low credit spreads, indexation and multi-decadal lows in call option prices.
Keywords: Call Options, Upside Risk, Tail Hedging
JEL Classification: G11
Suggested Citation: Suggested Citation