Why Is a Deep OTM Option Often Chosen for Portfolio Insurance despite High Basis Risk? ▴ Learn

Why Is a Deep OTM Option Often Chosen for Portfolio Insurance despite High Basis Risk?

A deep out-of-the-money (OTM) option is chosen for portfolio insurance because it is significantly cheaper than an ATM or ITM option. The hedger accepts the higher basis risk and the risk of the option expiring worthless in exchange for a much lower premium cost, effectively insuring against only catastrophic, large-scale price drops.

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