Deliberately Under-Hedging

The instinct when you have a risk is to eliminate it, but a hedge is never free — it costs the bid-ask spread on the hedging instrument, ties up margin, and if it's an options-based hedge it costs premium that eats directly into expected return. Deliberately under-hedging means choosing to leave part of an exposure unhedged on purpose, not because you couldn't afford the trade, but because you've decided the cost of full protection outweighs the risk you're accepting by carrying some of it yourself.

A common reason to do this is that the exposure isn't isolated: a desk with several related positions may find that risks partially offset each other already, so hedging each one to zero independently would mean paying to remove risk that a sister position was already canceling out for free. Another reason is a view on the risk itself — if a desk believes a particular exposure is more likely to help than hurt, under-hedging is a way to keep some of that exposure as a small, deliberate bet rather than paying to neutralize something with positive expected value. A third reason is simply that full hedging isn't available at a sane price: hedging the last 10% of an exposure in an illiquid instrument might cost far more per unit of risk removed than the first 90% did, so a desk caps the hedge ratio below 100% and holds the residual as accepted risk.

The discipline that separates deliberate under-hedging from just being sloppy is sizing and monitoring: the unhedged residual is measured, limited, and reported like any other risk position, with an explicit answer to "how much could this cost us and are we comfortable with that." Under-hedging without that discipline is simply an unmanaged risk wearing a hedge's name.