Risk management of carry trade with options

Abstract

his paper examines currency carry trades as well as an extension to the strategy by embracing options for risk management. Due to severe losses by Norwegian investors due to exchange rate movements during the financial crisis’ of 2007-2012, a Norwegian carry trade perspective is also studied. Our results show that including options for risk management increases Sharpe ratios significantly on all levels as well as substantially reducing volatility. Especially in times of extreme financial incidents, the use of options emerges as an essential tool of risk reduction and loss-minimization. Our results conclude that by excluding the use of options in a simple carry trade strategy, an investor will in many cases undertake an excessive amount of risk.