Can a Trader Use Options to Hedge against Basis Risk?
Yes, a trader can use options, specifically options on the underlying asset, to manage or hedge against basis risk, although it is complex. For example, a trader with a short futures hedge faces risk if the basis strengthens unexpectedly.
They could buy a put option on the spot asset. If the basis strengthens (spot rises relative to futures), the put option's value might increase, offsetting the loss from the imperfect hedge.
This is a form of dynamic hedging against price uncertainty.
Glossar
Short Futures Hedge
Strategy ⎊ A short futures hedge is a risk management strategy employed by market participants to mitigate potential losses from a decline in the price of an underlying asset they own.
Put Option
Insurance ⎊ Purchasing a Put Option functions as a form of portfolio insurance, establishing a guaranteed minimum selling price for the underlying crypto asset.
Basis Risk
Exposure ⎊ The core of basis risk within cryptocurrency derivatives, particularly options, stems from the imperfect correlation between the price movements of the underlying asset and its derivative contract.
Dynamic Hedging
Calibration ⎊ Dynamic hedging, within cryptocurrency and derivatives markets, represents a continuous rebalancing of a portfolio to maintain a desired risk exposure, typically delta neutrality for option positions.