Choosing the Right Derivative for Hedging

Very Hard Risk Management Derivatives In Risk Management

Emily is managing a diversified portfolio for a high-net-worth client with a significant exposure to technology stocks. Recent market volatility has raised concerns about potential downside risks. To mitigate these risks, Emily considers using derivatives as a hedging strategy. She evaluates three potential derivative instruments: index options, equity options on the technology stocks, and futures contracts on a technology sector index.

Emily believes that her client would prefer a strategy that provides flexibility and allows for adjustments without locking in loses. Additionally, the cost considerations and liquidity of these instruments are critical for making the right choice to protect against potential downturns.

Based on this information, which derivative instrument should Emily select to effectively hedge the portfolio against downside risk while aligning with her client's preferences?

Index options that provide the flexibility to sell at predetermined prices.

Futures contracts on a technology sector index which require margin and have less flexibility.

Equity options on individual technology stocks that are illiquid and costly.

Hint

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