Hedging tools, options

A separate consideration needs to be made for inventory, which in principle is used to be able to uncouple procuring from manufacturing and sales. In this regard it is mostly considered as a risk hedging strategy that increases costs. Finally, contracts, especially option contracts and futures, are other risk hedging tools. 

The spectrum of trading combinations and structured products involving options is constrained only by imagination and customer requirements. Virtually all participants in capital markets have some requirement that may be met by using options. Market makers, for instance, use options for speculation and arbitrage, to generate returns. One of the most important uses of options, however, is as hedging tools. 

In this chapter we have seen how interest rate options provide banks, investors, companies, and other users of the financial markets, with an immensely flexible set of tools for hedging against or taking advantage of European interest rate movements. 

Bond traders wishing to hedge the interest rate risk of their bond positions have several tools to choose from, including other bonds, bond futures, and bond options, as well as swaps. Swaps, however, are particularly efficient hedging instruments, because they display positive convexity. As explained in chapter 2, this means that they increase in value when interest rates fall more than they lose when rates rise by a similar amount—just as plain vanilla bonds do. 

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