In Page 128, under the section of “Changes in Hedging Techniques”, the following is written:“An equity market neutral fund is supposed to be zero beta or … But the risks of such funds are much different: In a dwon market a put option would provide less protection than outright short positions; a deep out-of-the-money option has little protection”. I intuitively undersstand why the put option offers less protection. The way I see it is as follows: The fund takes a long position in Stock X at $100 per share. It also takes a long position in the put option for X, and the strike price is $80. Say the stock market drops, so X drops to $70. There will be a loss of $30 in the long position of the stock. But there will be a gain of $10 (assume 0 option premium). In this case the gain from exercising the put is less than the losses incurred from the long position of the stock. Hence, this is why the option is unable to offer full protection. In the last statement, that a deep out-of-the-money option has little protection - that’s sure about it. But in the example I gave, the option is in-the-money but it also offers protection? Hence, why the last statement?
when the option is in the money - it helps you by giving you some protection - in the sense your loss without the put would have been -30 - but with the put it is -20. but when option is Out of the money - you have NO protection at all. “Little protection” is a relative term. I hope I am getting it right.
I just referred to the Schweser notes…I think it is clearer there. " This change in value may not fully protect the fund’s position, ESPECIALLY in the case of OOTM options" The impression that I got from the text is that ONLY OOTM options offer little protection (as a matter of fact I think it offers 0 protection since you lose the premium). I am hoping that my way of seeing things is right!!