Thus, operation risk measures may be used to protect hedges from volatile price movements. Insofar as risk management is concerned with extreme events that are not easily forecasted, the need for limits on all unhedged as well as hedged transactions in a portfolio is clear. While some companies have reduced their futures hedging activity as a result of unexpectedly large losses, leaving transactions unhedged is a strategic decision to be entered into cautiously. Rather than leaving transactions unhedged, volatility can be controlled by constructing business obligations with pricing optionality so as to reduce the need for potentially unprofitable hedging. The use of derivatives by risk managers has increased dramatically in the last two decades.
Financial derivatives are central to both portfolio optimization and risk management.
As risk management teams and their functions have become more prominent, the language of derivatives has become more familiar at the highest levels of business. This has assured the development of a risk-savvy culture throughout all levels of trading companies, and continued growth of the market for financial derivatives. Futures may not always be the most appropriate choice when attempting to reduce risk and keep transaction costs low when considering extreme price volatility. Therefore, measures that address operation and price risk are central to an effective overall trading and risk management program. Such risk management guidelines and limits provide an important framework within which transactions may be executed and business opportunities considered.