This lesson examines the strategic use of options and the process of selecting the most appropriate hedging instrument.

7.1 Options for Hedging
Options offer a key advantage over forwards: they protect against adverse movements while allowing the company to benefit from favourable movements .

  • Protective Puts: Buying a put option to protect against a decline in the price of an asset.

  • Covered Calls: Selling a call option against an asset you own to generate income.

7.2 Comparing Hedging Instruments
Treasurers must compare the features of different instruments :

  • Cost: Forwards are typically zero-cost; options require a premium.

  • Protection: Forwards provide full protection; options provide protection with upside potential.

  • Flexibility: Forwards are rigid; options offer flexibility.

7.3 Hedge Effectiveness
Hedge effectiveness is the degree to which a hedging instrument offsets the risk it is intended to hedge. The ACT syllabus  includes testing “hedge effectiveness” as a key competency.

7.4 Strategic Decision-Making
The selection of a hedging strategy depends on:

  • The nature of the exposure (transaction, translation, economic).

  • The company’s risk appetite.

  • The cost of the hedging instrument.

  • The market’s view on future interest rates and exchange rates.

  • Accounting and tax implications.

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