Define the Term "Tail Risk" and How It Relates to Short-Term Hedging ▴ Learn

Define the Term “Tail Risk” and How It Relates to Short-Term Hedging.

Tail risk is the risk of an extremely rare and unexpected event that causes a massive loss, often represented by the "fat tails" of a probability distribution. Short-term hedging, especially with out-of-the-money options, can be ineffective against tail risk because the option may expire before the extreme event occurs.

A proper tail-risk hedge requires a long-dated, deep out-of-the-money option or a strategy designed to protect against massive, sudden market moves.

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