Reactive hedging is a risk management strategy implemented in response to realized or imminent adverse market movements affecting an existing asset or liability position. Unlike proactive hedging, which anticipates future risk, this approach aims to mitigate losses after an undesirable market event has occurred or is clearly unfolding. In crypto, it involves taking hedging positions only after a significant price drop or increased volatility is observed in a digital asset portfolio.
Mechanism
The operational logic dictates that hedging instruments are acquired or adjusted in direct response to predefined triggers, such as a cryptocurrency reaching a specific price threshold or a sudden spike in implied volatility. This typically involves executing trades in derivatives like futures or options to offset the observed losses in the spot market. The timing of execution is critical, aiming to limit further depreciation of the underlying asset.
Methodology
The strategic approach recognizes that certain risks are difficult to anticipate or are uneconomical to hedge proactively, thus accepting some initial loss to prevent larger future ones. It requires rapid decision-making and efficient trade execution capabilities within institutional trading systems. While potentially incurring higher transaction costs due to reactive market conditions, this method offers a pragmatic approach to managing sudden, unforeseen market shifts in crypto institutional options and spot trading.
Proactive hedging uses linear instruments like forwards to lock in rates for forecasted exposures; reactive hedging uses non-linear options to manage risk for confirmed or contingent events.
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