Re page 187 of Schweser book 3, “Currency Mangement: An Introduction” - PUT Spreads
So obviously we can protect an asset (currency in this case) through perfect hedging with forward contracts - where there is no downside risk or upside potential. But one of the strategies that is a cheaper alternative is to use a put spread, where you buy an OTM put at X(high) and sell a further OTM put at X(low). Sure, we’re protected down to X(high) and we reduce the initial premium cost with the written put, but if the price drops to X(low), we would be forced to buy the underlying asset from the person we sold the put to. How would this be a viable strategy? Am i missing something here?
assume both options have the same expiration and assume you have the underlying asset tied to the puts.
suppose that during expiration day, the asset drops to X(low) and so, you buy the asset from the counterparty for X(low) but you still have the long put at X(high) and exercise it. you can either use the asset you get from the short put and use it for the long put and leave your original underlying asset unprotected (which therefore now has X(low) in value). or you can exercise the long put for your original underlying asset at X(high) and then get the asset from the short put at X(low).
either way, your position value is now at X(low) + [X(high) - X(low)] which is just X(high).