Risk
Tail-risk hedging
Deliberately paying a small ongoing cost to limit losses in a severe market fall.
How it works
The usual implementation is buying out-of-the-money put options, which cost money in almost every period and pay substantially in a crash.
It is insurance, with insurance economics: a negative expected return most years, bought because the loss it covers is unacceptable rather than merely unpleasant.
Where it misleads people
The cost compounds against you. Many hedging programmes have lost more in premiums over a decade than they paid out in the crash they were bought for.
Related terms
- Put optionThe right to sell an asset at a fixed price before a set date.
- Black swanA rare, high-impact event that was not predicted and is explained confidently afterwards.
- HedgingTaking an offsetting position to reduce a specific risk you do not want.
- SkewnessWhether a return distribution leans towards large gains or large losses.
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Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.