Many a times, we have a choice between use of futures, swaps & options for various hedging activities. For example, 1. Reducing duration for a fixed income p/f - can be done by shorting a fixed income future or via a fixed-pay swap 2. Moving $$ from large cap to mid cap - done via futures or via equity swap 3. You can use swaptions, caps, interest rate (call) options for protection against interest rate increases if you are a floating rate borrower… If you are given multiple choices to pick between these derivatives, what would be criteria you would use to select between them? I know this is a generic question, but thought would be useful to list the things to “look out for”… Thanks! - BN
Lots of things can factor into the decision but the key rule I’ve come across is that if you’re only concern is to protect against a downward move in the underlying asset you’re holding, use futures. If you have no opinion on things one way or another, use options. The advantage of using options is that you get asymmetical payoffs. For example,if the underlying you’re holding doesn’t fall in value, all you lose is the option premium whereas with a futures contract, you’re on the hook for the amount that it changed in value (zero sum game).