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7.3 Option Strategies & Risk Management

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Canadian Securities Course CSC

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1 Introduction & Exam Overview

About the CSC Exams

2 Chapter 1: The Canadian Investment Marketplace

1.1 The Canadian Securities Industry & the Investment Dealer's Role 1.2 Financial Intermediaries: Banks, Trusts, Credit Unions, Insurers & Pension Funds 1.3 Financial Market Trends 1.4 Investment Capital, Financial Instruments & Financial Markets 1.5 Canadian Exchanges, ATSs, Dark Pools & the Order Protection Rule 1.6 Canadian Securities Regulators, the CSA & CIRO 1.7 Investor Protection: OSFI, CIPF and CDIC 1.8 Ethics, Standards of Conduct & the Client Focused Reforms 1.9 Conflicts of Interest, Complaint Handling & Remediation

3 Chapter 2: The Economy

2.1 Economics Foundations & Measuring Economic Growth 2.2 The Business Cycle & Economic Indicators 2.3 Inflation & Interest Rates 2.4 The Labour Market & Unemployment 2.5 The Bank of Canada & the Inflation-Control Target 2.6 Implementing Monetary Policy: The Operating Band, Market Operations & Transmission 2.7 Fiscal Policy, Deficits & the Challenges of Government Policy 2.8 International Finance & Trade: The Balance of Payments and the Canadian Dollar

4 Chapter 3: Features and Types of Fixed-Income Securities

3.1 The Fixed-Income Marketplace, Bond Terminology & Security 3.2 Protective Covenants, Retirement Provisions & Extendible/Retractable Features 3.3 Government of Canada Securities: T-Bills, Marketable Bonds & RRBs 3.4 Provincial & Municipal Debt and Strip Bonds 3.5 Corporate Bonds, Credit Spreads & Bond Ratings 3.6 Money Market Instruments, Floating-Rate Notes & International Bonds 3.7 Other Fixed-Income Securities & Reading Bond Quotes

5 Chapter 4: Pricing and Trading of Fixed-Income Securities

4.1 Bond Pricing, Price–Yield Relationships & Accrued Interest 4.2 Yield Calculations & Return Measures 4.3 The Term Structure of Interest Rates & Yield Curve Theories 4.4 Fundamental Bond Pricing Properties: Volatility Rules, Duration & Convexity 4.5 Bond Market Trading & Bond Indexes

6 Chapter 5: Common and Preferred Shares

5.1 Common Shares: Ownership Rights, Voting & Restricted Shares 5.2 Dividends, DRIPs, Stock Splits & Consolidations 5.3 Preferred Shares: Features, Cumulative Dividends & Taxation 5.4 Preferred Share Variations: Convertible, Callable, Retractable, Floating & Rate-Reset 5.5 Fundamental Equity Metrics & Ratios 5.6 Stock Indexes & Averages

7 Chapter 6: Equity Transactions

6.1 Order Types, Execution & Market Mechanics 6.2 Margin Trading: Long Accounts & Borrowing 6.3 Short Selling & Short-Margin Requirements 6.4 Trading & Settlement Procedures: T+1, CDS & Confirmations

8 Chapter 7: Derivatives

7.1 Derivatives: Role, Underlying Assets & Users 7.2 Options Fundamentals: Calls, Puts & Moneyness 7.3 Option Strategies & Risk Management 7.4 Forward & Futures Contracts 7.5 Rights & Warrants

9 Chapter 8: Corporations and their Financial Statements

8.1 Corporate Structures & Corporate Governance 8.2 The Annual Report, Accounting Standards & the Auditor's Report 8.3 The Balance Sheet & Income Statement 8.4 The Cash Flow Statement & Earnings Quality 8.5 Public Company Disclosure, Investor Rights, Take-Over Bids & Insider Trading

10 Chapter 9: Financing and Listing Securities

9.1 Government & Corporate Financing: Underwriting and Syndicates 9.2 The Prospectus Process, Stabilization & Purchaser Rights 9.3 The Exempt Market & Private Placements 9.4 The Listing Process: TSX, TSXV & Capital Pool Companies 9.5 Continuous Disclosure, Material Changes & Insider Reporting

11 Chapter 10: Investment Analysis

10.1 Methods of Equity Analysis & Macroeconomic Analysis 10.2 Fundamental Industry Analysis 10.3 Company Analysis: Competitive Advantages, Governance & the Dividend Discount Model 10.4 Discounted Cash Flow & Relative Valuation Multiples 10.5 Financial Statement Ratio Analysis 10.6 Assessing Preferred Share Investment Quality 10.7 Technical Analysis: Charts, Trends & Patterns 10.8 Technical Indicators, Volume, Breadth & Sentiment

12 Chapter 11: Portfolio Analysis

11.1 Measuring Investment Return 11.2 Measuring Risk: Types of Risk, Standard Deviation & Downside Measures 11.3 Portfolio Risk & Return: Correlation and Diversification 11.4 Beta, the Capital Asset Pricing Model & the Security Market Line 11.5 Portfolio Manager Styles: Equity & Fixed Income 11.6 The Portfolio Management Process: Objectives, Constraints & the IPS 11.7 Asset Mix, Monitoring, Performance Evaluation & Rebalancing

13 Chapter 12: Alternative Investments, Other Managed, and Structured Products

12.1 Alternative Investments: Structures, Fees & Liquid Alternatives 12.2 Alternative Strategies, Performance Measurement & Due Diligence 12.3 Segregated Funds, Labour-Sponsored Funds & Listed Private Equity 12.4 Income Trusts, REITs & Closed-End Funds 12.5 Structured Products: PPNs & Market-Linked GICs 12.6 Split Shares & Asset-Backed Securities

14 Chapter 13: Mutual Funds

13.1 Managed Products & Mutual Fund Structure 13.2 Pricing Mutual Fund Units: NAVPS & Forward Pricing 13.3 Mutual Fund Fees, Sales Charges & Unit Series 13.4 Mutual Fund Regulation, Fund Facts & Account Opening 13.5 Types of Mutual Funds & Fund Management Styles 13.6 Redemptions, Withdrawal Plans & Measuring Fund Performance

15 Chapter 14: Exchange-Traded Funds (ETFs)

14.1 ETF Origins, Structure, Tax Efficiency & ETF Facts 14.2 ETF Creation, Redemption & Arbitrage 14.3 Types of ETFs & Advanced Strategies 14.4 Comparing ETFs, Mutual Funds & Individual Securities

16 Chapter 15: Working with the Institutional Client

15.1 The Institutional Marketplace & Institutional Clients 15.2 Institutional Investment Guidelines, Styles & Restrictions 15.3 Buy Side & Sell Side: Trading Desks, Revenue, Clearing & Best Execution 15.4 Block Trading, Dark Pools & Algorithmic Trading

17 Chapter 16: Fee-Based Accounts and Working with the Retail Client

16.1 Fee-Based Accounts: Managed & Non-Managed Models 16.2 Fee Transparency, CRM2 & Total Cost Reporting, and MWRR vs. TWRR 16.3 The Financial Planning Approach & the Life Cycle 16.4 Behavioral Finance, Sequence-of-Returns Risk & Client Coaching 16.5 Estate Planning Basics

18 Chapter 17: Canadian Taxation

17.1 The Canadian Taxation System 17.2 Taxation of Investment Income 17.3 Capital Gains, Losses & The Superficial Loss Rule 17.4 Registered vs Non-Registered Tax-Advantaged Accounts 17.5 Tax Planning Strategies, Pension Plans & the RDSP

7.3 Option Strategies & Risk Management

Key Takeaways Explain This Topic AI

Covered call writing involves selling call options against an equivalent position in long shares, generating upfront income and a mild downside cushion in exchange for capping upside capital gains at the strike price.

A protective put (married put) pairs a long stock position with a purchased put option, acting as portfolio insurance that guarantees an absolute price floor while preserving unlimited upside participation above the break-even price.

A long straddle involves purchasing both a call and a put with the identical strike price and expiration date, creating a market-neutral strategy that profits from large directional volatility in either direction that exceeds the combined premium paid.

Writing uncovered (naked) call options carries theoretically unlimited financial risk, whereas options used as risk management tools transform, bound, or truncate portfolio risk distributions.

Canadian exchange-traded options trade exclusively on the Bourse de Montréal (MX) and are cleared by the Canadian Derivatives Clearing Corporation (CDCC), which guarantees trade execution and manages automated assignment processes.

Last updated: October 2026

While individual calls and puts provide standalone speculative vehicles, their true institutional power emerges when combined with underlying equity positions or other derivative contracts to form structured option strategies . In portfolio management, options are utilized extensively to manage downside risk, monetize existing assets through yield enhancement, and monetize volatility expectations.

1. Options in Portfolio Management: Hedging vs. Speculation

Investors employ options across two fundamentally contrasting philosophical mandates:

Speculative Leverage: Utilizing options to gain disproportionate exposure to price movements with a fraction of the capital required to purchase physical stock. While the potential percentage return is magnified, option buyers risk a 100% loss of invested capital upon expiration.

Risk Mitigation & Hedging: Restructuring portfolio risk by eliminating catastrophic downside liabilities or locking in liquidation floors. Unlike stop-loss orders—which convert to market orders and suffer severe execution slippage during gap-downs—options provide contractually guaranteed price boundaries irrespective of overnight market crashes.

2. Covered Call Writing: Income Generation and Yield Enhancement

A covered call (or buy-write strategy) is one of the most widely utilized and conservative option strategies in Canadian wealth management. It involves owning shares of an underlying stock while simultaneously writing (selling) call options against that exact share position on a share-for-share basis (1 call contract per 100 shares held). Covered Call Structural Mechanics:

  • [ Long 100 Shares Stock ] + [ Short 1 Call Option Contract ]
  • | |
  • Provides Downside Generates Upfront
  • Collateral for Option Cash Flow Premium
  • \ /
  • +--------------+----------------+
  • |
  • v

[ Synthetically Modified Payoff:

  • Enhanced Yield, Capped Upside ]
  • Investor Motivation and Strategic Outlook

Market Outlook: Neutral to mildly bullish . The investor expects the stock to trade sideways, rise modestly, or experience low volatility.

Primary Objective: Income generation . The investor seeks to boost portfolio cash yield by collecting recurring option premiums, transforming non-dividend-paying or low-dividend stocks into cash-flow-generating assets.

Secondary Objective: Downside buffer . The collected premium provides a modest financial cushion against minor downward price corrections.

Financial Formulas for Covered Calls

Maximum Gain: Occurs at any stock price at or above the strike price ( K K K ) at expiration: Maximum Gain = ( K − S purchase ) + Call Premium Received \text{Maximum Gain} = (K - S_{\text{purchase}}) + \text{Call Premium Received} Maximum Gain = ( K − S purchase ​ ) + Call Premium Received

Break-Even Price: The stock price below which the investor begins to suffer net losses: Break-Even Price = S purchase − Call Premium Received \text{Break-Even Price} = S_{\text{purchase}} - \text{Call Premium Received} Break-Even Price = S purchase ​ − Call Premium Received

Maximum Loss: Occurs if the underlying stock drops to $0.00 : Maximum Loss = S purchase − Call Premium Received \text{Maximum Loss} = S_{\text{purchase}} - \text{Call Premium Received} Maximum Loss = S purchase ​ − Call Premium Received The investor remains exposed to catastrophic equity risk, tempered only by the premium collected.

Comprehensive Worked Numeric Walkthrough: Covered Call

An advisor manages a portfolio holding 1,000 shares of BCE Inc. (BCE) acquired at $50.00 per share . With BCE trading near $50.00, the advisor writes 10 BCE Nov 52 Calls at a premium of $2.00 per share ($200 per contract), collecting $2,000 in immediate cash flow .

  • Initial Stock Value: 1,000 × $50.00 = $50,000
  • Cash Premium Collected: 10 × 100 × $2.00 = $2,000
  • Per-Share Break-Even: $50.00 - $2.00 = $48.00

Per-Share Maximum Gain: ($52.00 - $50.00) + $2.00 = $4.00 ($4,000 total or an 8.0% return over the holding period)

Stock Price at Expiry Stock Value (1,000 sh) Option Outcome / Obligation Total Combined Value Net Profit / (Loss)

  • $35.00 $35,000 Calls expire OTM; keep $2,000 premium $37,000 -$13,000 (Full loss minus $2k)
  • $45.00 $45,000 Calls expire OTM; keep $2,000 premium $47,000 -$3,000
  • $48.00 $48,000 Calls expire OTM; keep $2,000 premium $50,000 $0.00 (Break-Even)
  • $50.00 $50,000 Calls expire ATM; keep $2,000 premium $52,000 +$2,000
  • $52.00 $52,000 Calls expire ATM; keep $2,000 premium $54,000 +$4,000 (Max Gain Reached)

$60.00 $60,000 Assigned! Sell 1,000 sh at $52; keep $2k $54,000 +$4,000 (Upside Capped!) Covered Call Profit/Loss Profile:

  • Profit ($)
  • ^
  • +$4.00 -+ +================== (Capped at $52 Strike)
  • | /
  • | /
  • $0 -+------------------/---------------------> Stock Price
  • | / \
  • | / Break-Even = $48.00
  • $48.00 +===============+
  • | (Loss if Stock Drops to $0)
  • +---------------------------------------->
  • The Strategic Trade-Off of Covered Calls

The investor gives up all capital appreciation above the strike price in exchange for a fixed upfront premium. If BCE skyrockets to $65.00 on a buyout announcement, the shares are called away at $52.00, leaving the covered call writer with regret risk (opportunity cost).

3. Protective Puts: Portfolio Insurance Against Catastrophic Decline

A protective put (sometimes called a married put when acquired simultaneously with the stock) pairs a long position in a common stock with a long put option contract on the same security. Protective Put Architecture:

  • [ Long 100 Shares Stock ] + [ Long 1 Put Option Contract ]
  • | |
  • Provides Growth Provides Guaranteed
  • and Dividend Flow Selling Floor
  • \ /
  • +--------------+----------------+
  • |
  • v

[ Synthetically Modified Payoff:

  • Unlimited Upside, Truncated Downside ]
  • Investor Motivation and Strategic Outlook

Market Outlook: Bullish long-term , but acutely concerned about near-term market turbulence, systemic shocks, negative regulatory rulings, or volatile earnings reports.

Primary Objective: Capital preservation . The put establishes an irrevocable, contractually guaranteed floor price below which the investor's capital cannot fall, regardless of how far the stock drops.

Advantage Over Stop-Loss Orders: A stop-loss order placed at $90 triggers a market sell order when hit; if an overnight corporate disaster causes the stock to gap open at $65, the stop-loss executes near $65. In contrast, a protective put with a $90 strike guarantees the right to sell at exactly $90.00 , completely immune to gap risk.

Financial Formulas for Protective Puts

Guaranteed Selling Floor: The strike price of the put ( K K K ).

Effective Floor Value: K − Put Premium Paid K - \text{Put Premium Paid} K − Put Premium Paid .

Maximum Loss: Occurs if the stock price finishes at or below the put strike price at expiration: Maximum Loss = ( S purchase − K ) + Put Premium Paid \text{Maximum Loss} = (S_{\text{purchase}} - K) + \text{Put Premium Paid} Maximum Loss = ( S purchase ​ − K ) + Put Premium Paid

Break-Even Price: The stock must appreciate sufficiently to cover the cost of the insurance: Break-Even Price = S purchase + Put Premium Paid \text{Break-Even Price} = S_{\text{purchase}} + \text{Put Premium Paid} Break-Even Price = S purchase ​ + Put Premium Paid

Maximum Gain: Theoretically unlimited , tracking the stock higher dollar-for-dollar minus the initial insurance premium paid: Maximum Gain = Stock Price at Exit − ( S purchase + Put Premium Paid ) \text{Maximum Gain} = \text{Stock Price at Exit} - (S_{\text{purchase}} + \text{Put Premium Paid}) Maximum Gain = Stock Price at Exit − ( S purchase ​ + Put Premium Paid )

Comprehensive Worked Numeric Walkthrough: Protective Put

An investor holds 500 shares of Canadian Pacific Kansas City (CP) trading at $100.00 per share . Concerned about an upcoming macroeconomic trade tariff announcement, the investor purchases 5 CP 95 Puts maturing in three months for a premium of $3.50 per share ($350 per contract), paying $1,750 in total insurance premium .

  • Total Initial Capital Invested: (500 × $100.00) + $1,750 = $51,750
  • Per-Share Break-Even Price: $100.00 + $3.50 = $103.50
  • Per-Share Maximum Loss: ($100.00 - $95.00) + $3.50 = $8.50 ($4,250 total maximum loss)

Stock Price at Expiry Stock Value (500 sh) Put Value / Exercise Payoff Total Combined Value Net Profit / (Loss)

  • $0.00 $0 Exercise Put: Sell 500 sh at $95 = $47,500 $47,500 -$4,250 (Protected!)
  • $70.00 $35,000 Exercise Put: Sell 500 sh at $95 = $47,500 $47,500 -$4,250 (Protected!)
  • $95.00 $47,500 Put expires ATM ($0 value) $47,500 -$4,250 (Max Loss Floor)
  • $100.00 $50,000 Put expires OTM ($0 value) $50,000 -$1,750 (Cost of Insurance)
  • $103.50 $51,750 Put expires OTM ($0 value) $51,750 $0.00 (Break-Even)

$120.00 $60,000 Put expires OTM ($0 value) $60,000 +$8,250 (Unlimited Upside) Protective Put Profit/Loss Profile:

  • Profit ($)
  • ^ / (Unlimited Upside)
  • | /
  • | /
  • $0 -+----------------------------/----------> Stock Price
  • | / \
  • | / Break-Even = $103.50
  • $8.50 +=========================+
  • | (Guaranteed Max Loss Floor)
  • +--------------------------------------->
  • Strike ($95)
  • The Cost of Protection

The primary drawback of the protective put is the drag on total return . If the market remains stable or rises, the put expires worthless, and the recurring cost of buying protective puts reduces long-term portfolio compounding.

4. Volatility Trading: The Long Straddle

A long straddle is a market-neutral options strategy designed to exploit extreme price volatility regardless of the direction in which the stock breaks. Long Straddle Architecture:

  • [ Buy 1 Call Option (Strike K) ] + [ Buy 1 Put Option (Strike K) ]
  • \ /
  • +------------------+------------------+
  • |
  • v
  • Both options share IDENTICAL underlying stock,
  • IDENTICAL strike price (K), and IDENTICAL expiry
  • Strategic Thesis and Application

Market Outlook: Highly volatile / non-directional . The trader expects a massive price explosion but cannot predict whether the catalyst will be overwhelmingly positive or catastrophically negative.

Typical Catalysts: Pending Phase III clinical biotech trial results, Supreme Court patent rulings, high-stakes regulatory decisions on corporate takeovers, or high-uncertainty quarterly earnings reports.

Financial Formulas for Long Straddles

Total Cost (Combined Premium): Total Premium = Call Premium + Put Premium \text{Total Premium} = \text{Call Premium} + \text{Put Premium} Total Premium = Call Premium + Put Premium

Upper Break-Even Point: Upper Break-Even = K + Total Premium \text{Upper Break-Even} = K + \text{Total Premium} Upper Break-Even = K + Total Premium

Lower Break-Even Point: Lower Break-Even = K − Total Premium \text{Lower Break-Even} = K - \text{Total Premium} Lower Break-Even = K − Total Premium

Maximum Loss: Occurs if the underlying stock finishes exactly at the strike price K K K at expiration, causing both the call and the put to expire completely worthless: Maximum Loss = Total Premium Paid \text{Maximum Loss} = \text{Total Premium Paid} Maximum Loss = Total Premium Paid

Maximum Gain:

Upside: Theoretically unlimited as the stock price rallies toward infinity.

Downside: Substantial , equal to K − Total Premium K - \text{Total Premium} K − Total Premium if the stock plummets to $0.00.

Worked Numeric Walkthrough: Long Straddle

A junior Canadian uranium exploration company trades at $30.00 per share ahead of an environmental permit decision. An investor purchases 1 Oct 30 Call for $2.50 and 1 Oct 30 Put for $2.00 .

  • Total Premium Outlay: $2.50 + $2.00 = $4.50 ($450.00 per straddle)
  • Maximum Loss: $4.50 ($450.00 per straddle)
  • Upper Break-Even Price: $30.00 + $4.50 = $34.50
  • Lower Break-Even Price: $30.00 - $4.50 = $25.50
  • Stock Price at Expiration Call Payoff Put Payoff Total Gross Payoff Net Profit / (Loss)
  • $15.00 $0.00 $15.00 $15.00 +$10.50 (+$1,050.00)
  • $25.50 $0.00 $4.50 $4.50 $0.00 (Lower Break-Even)
  • $30.00 $0.00 $0.00 $0.00 -$4.50 (Max Loss: -$450.00)
  • $34.50 $4.50 $0.00 $4.50 $0.00 (Upper Break-Even)

$45.00 $15.00 $0.00 $15.00 +$10.50 (+$1,050.00) Long Straddle Profit/Loss Profile:

  • Profit ($)
  • ^
  • | \ / (Profits in Both Directions)
  • | \ /
  • $0 -+-----\-------------------------/--------> Stock Price
  • | \ /
  • $4.50 + \ /
  • | \ /
  • | +-----------------+
  • | Lower BE Upper BE
  • | ($25.50) ($34.50)
  • +------------------+--------------------->
  • Strike
  • ($30.00)
  • 5. Canadian Derivative Infrastructure: MX and CDCC

Canada operates an integrated, secure national marketplace for financial derivatives. Understanding its structure is vital for regulatory and operational compliance under Canadian securities rules.

The Bourse de Montréal (MX)

The Bourse de Montréal (MX) , a subsidiary of TMX Group, is Canada's dedicated national exchange for financial derivatives. The MX provides:

Fully automated electronic order matching.

Rigorous market surveillance and trade reporting.

Standardized option contract specifications for Canadian equities, ETFs, and indices.

The Canadian Derivatives Clearing Corporation (CDCC)

The Canadian Derivatives Clearing Corporation (CDCC) is the central clearinghouse for all exchange-traded derivative transactions executed on the MX. The CDCC performs several crucial functions: CDCC Core Operational Cycle:

1. Trade Execution: Buyer and Seller match order on Bourse de Montréal (MX).

2. Novation: CDCC steps in, severing direct bilateral link.

CDCC becomes Buyer to every Seller, Seller to every Buyer.

3. Collateral & Margin: CDCC collects initial and daily mark-to-market margin.

4. Exercise & Assignment: CDCC processes exercise notices and assigns randomly

to clearing member dealer firms.

5. Settlement: CDS Clearing handles physical equity delivery under T+1.

Novation and Clearing Guarantee: CDCC eliminates counterparty default risk for market participants. Even if a brokerage firm defaults, CDCC guarantees trade settlement using its clearing fund and credit facilities.

The Assignment Process: When a long call or put holder decides to exercise their option, their broker submits an exercise notice to the CDCC. The CDCC assigns the notice to a clearing member firm with open short positions on a random basis . The member firm then assigns the exercise to a specific short client account using either a random selection or first-in, first-out (FIFO) methodology approved by CIRO.

Physical Equity Settlement via CDS: When equity option exercise occurs, the physical transfer of shares and cash settles through CDS Clearing and Depository Services Inc. on the standard Canadian T+1 settlement schedule .

6. Synthesis: Strategic Option Matrix

Strategy Component Positions Market Bias Max Gain Max Loss Break-Even Point(s) Primary Portfolio Purpose

Covered Call Long 100 Shares + Short 1 Call Neutral to Mildly Bullish ( K − S 0 ) + P (K - S_0) + P ( K − S 0 ​ ) + P S 0 − P S_0 - P S 0 ​ − P S 0 − P S_0 - P S 0 ​ − P Yield enhancement; monetizing existing equity holdings

Protective Put Long 100 Shares + Long 1 Put Bullish Long-Term Unlimited ( S 0 − K ) + P (S_0 - K) + P ( S 0 ​ − K ) + P S 0 + P S_0 + P S 0 ​ + P Portfolio insurance; catastrophic downside risk truncation

Long Straddle Long 1 Call + Long 1 Put (Same K K K & Exp) Volatile / Non-Directional Unlimited (Upside) / K − P tot K - P_{\text{tot}} K − P tot ​ (Down) Total Premium ( P call + P put P_{\text{call}} + P_{\text{put}} P call ​ + P put ​ ) K ± P tot K \pm P_{\text{tot}} K ± P tot ​ Profiting from large directional explosions ahead of catalysts

Naked Short Call Short 1 Call (Unhedged) Bearish to Neutral Premium Received Theoretically Unlimited K + P K + P K + P Speculative income generation with extreme tail risk