In a hedging strategy, why is a combination of long put options and short forward contracts often employed?

The practice of employing a combination of long put options and short forward contracts in a hedging strategy primarily focuses on managing risk, particularly when selling the base currency. A long put option gives the holder the right to sell an asset at a predetermined price, thus providing downside protection if the asset's price falls below that level. On the other hand, a short forward contract obligates the seller to deliver an asset at a predetermined price at a future date, establishing a commitment to sell the asset.

By combining these two strategies, the hedger can effectively protect against unfavorable movements in currency exchange rates. The long put option serves as insurance against a significant drop in the price of the asset, while the short forward contract locks in a selling price, ensuring that the seller will receive a specific amount regardless of potential negative market fluctuations.

This approach does not aim to eliminate risks completely; instead, it seeks to balance exposure and stabilize returns, allowing for better management of potential losses when dealing with the base currency. Thus, the focus on risk management, particularly in the context of selling the base currency, is the driving rationale behind this combination of strategies.