Hey guys,
Is purchasing put options on your concentrated position stock an example of a cross hedge or a complete hedge?
I thought it was a complete hedge, but the text says its a cross hedge.
Does anybody agree with the text, and why?
Regards,
I thought the concept of Cross Hedging was introduced at Concentrated Single Asset Position under PWM.
Due to the limitation of directly hedging the underlying asset, investor might consider an indirect / cross hedging by using derivatives on a substitute asset with an expected high correlation with the investor’s concentrated stock position. This will hedge away the industry and market risk but still retains the company specific risk.
Based on what you said, “buy put options on your concentrated position” implicitly indicates those put options are directly on the exact assets? then it is a complete hedge. and if on correlated asset, it must be cross hedge.
Can you share more context and where you read it?
It depends on the underlying.
If you hold some stock that you believe correlates with the S&P, and the stock doesnt have an acceptable put option… you can buy S&P500 puts… that would be a cross hedge.
Howvever, if you can locate the exact underlying put option and you feel it is the right time and strike, then you have a complete hedge.
I presume that we’re talking about currencies here.
Suppose that your home currency is the CAD and that you’re investing in assets denominated in ARS (Argentine pesos). Suppose, further, that USD and CAD have a strong, positive (price) correlation and that MXN and ARS have a strong, positive (price) correlation.
If you hedge your investment with ARS/CAD derivatives (puts, calls, forwards, futures, swaps, FRAs, whatever), that’s a _ direct _ hedge. If you hedge it with ARS/USD derivatives, that’s a _ cross _ hedge, and if you hedge it with MXN/CAD derivatives, that’s a _ proxy _ hedge (which some authors mistakenly call a cross hedge).
So, the answer to your question depends on the currencies in the puts compared to the currencies in your original transaction.
Properly, that would be a _ proxy _ hedge, not a cross hedge.