A question from an interview book:
When can hedging an options position make you take on more risk?
The answer provided is the following:
Hedging can increase your risk if you are forced to both buy short-dated options and hedge them.
And it gives an example that you short the stock to hedge, and the stock price rises up to strike so the option expires worthless, then you lose on both the options and the short stock position. Therefore you are worse off than if you had not hedged.
What I don't quite understand is that, in that example, if the stock price goes down, I would gain on my short stock position, why didn't it being taken into account? Also, I hope to have an analytical formula to see the "risk" more clearly.
Could anyone help me with this one?
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