- The main difference between cash as a hedge against systemic risk and, say, put options is that a dollar of cash remains a dollar of cash regardless of the market, but option values change as either the underlying asset moves down or as the perception of risk changes.
- Currently short-term rates are close to zero, so saving a large amount of cash creates a significant opportunity cost for the investor.
- In short, we believe guarding against the tails is best achieved by a mix of approaches rather than blind adherence to one.
The huge swoons seen in the stock market this past week raise the question that has been raised so many times in recent years: What should an investor do to weather extreme volatility? The most practical solutions include two choices at opposite extremes – hold cash or buy options-based hedges – with lots of alternatives in the middle. Which way is best and why?
