the fact that the price may fall and the option could therefore go in the money. The farther away from the market price your option at the time of purchase, the bigger the payout will be if the price is hit within the specified time. Lets say a US investor buys a foreign asset thats denominated in British pounds. For example, you could buy the EUR/USD currency pair in one account and sell the EUR/USD in the other account that does not charge for holding short positions overnight. It can also be used to protect against fluctuations in currency exchange rates when an asset is priced in a different currency to your own.
There are two triangles here if you consider both directions for each pair. There is buy, eurusd, sell, gpbusd, sell.
This is called the strike price. Thus to protect against gbpusd falling you would buy (go long) a gbpusd put option. Basic hedging strategy using put options Take the following example. This means that pair hedging could actually increase risk not decrease. The reason for using an out of the money put is that the option premium (cost) is lower but it still affords the carry trader protection against a severe drawdown.
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