Hedge or Sell?

Once an investor decides to reduce risk, the next choice is whether to sell or to hedge.

In this article we assume only long investing. For short portfolios, transactions would be in the opposite direction. The most important factors in making this decision are product availability, implementation costs, tax implications and the need for customised payoffs.

Implementation Costs

Futures are generally less costly to trade than the underlying costs. As a result, investors who need temporary risk reduction could benefit by hedging rather than selling out of their positions.

However, for longer-term asset allocation moves, trading the underlying might make sense. This is because futures rolling costs or swap financing spread costs could eventually outweigh the initial trading cost savings.

Futures could also be used for trading the...

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