Forward or Option: Lock or Flex
Distinguish a forward-style hedge from an option-style hedge using obligation, upside, and premium.
Principle: First decide whether you want a lock or a floor. Forward-Style Lock Forwards, futures, and many swaps create symmetrical outcomes. Gains on the exposure are offset by losses on the derivative, and losses on the exposure are offset by gains on the derivative. The result is a locked effective price or rate. Option-Style Flexibility Options create asymmetrical outcomes. The buyer pays a premium for a right. That right protects against the bad side while leaving a better market outcome available. Business Fit Use the lock when certainty is the point. Use the option when the business is willing to…
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