"Hedging increases your risk" - an anonymous trader, p.311 on "Dynamic Hedging"

An aggressive derivatives house lost a considerable amount of money on a trade where they managed to buy “cheap” volatility with a series of knock-out options using rebates, in fact obtaining a strip of American binary options. They had a considerable “margin” in the trade, which means that the trade went home with some theoretical marks-to-market profits and thought highly of himself.

The trader was asked by his boss to manage the risk and reduce the exposure. “Cash-in on the money,” he was told. This was a reference to the money they believed they had earned off the customer. So the trader examined the Greeks and sold the vega, to perfect the vega neutrality in a manner that would befit such a sophisticated house as his.

A few weeks later, the trader was out of a job. Volatility exploded and he lost considerable money due to the difference in convexity between the vegas he owned and the vegas he so massively sold. His boss, not very recipient about notions of fourth moments and other nerdy matters, fired him on grounds that the trader did not properly offer the exposure. Actually, the trader, hedging a double barrier with out-of-the-money options, was even short sixth moment.

The trader, like most derivatives traders who lose their jobs, landed himself a better position (he had gained valuable experience) and concluded with the following wisdom: Hedging increases your risks.