For decades, the best a company could do to protect itself from getting stuck with an uncollectible receivable from a customer bankruptcy was to make careful credit decisions; insist on cash in advance or letters of credit for new orders; or buy credit insurance on a broad portfolio of receivables, most of which were almost certainly collectible. None were foolproof, and some proved expensive. But the innovative capital markets have developed a product that allows companies to hedge only the bad apples. Accounts receivable (A/R) put options are not cheap, but they provide a specific hedge only where it’s warranted. “You buy insurance for unseen risks; you buy a put option for a seen risk,” notes trade credit consultant David Schmidt, principal of A2 Resources, based in Yardley, Pa. “At first, only a few boutiques were doing it, but now there are a ton.”
But while more hedge funds and investment banks are offering A/R puts, many finance professionals remain unclear as to how and when to use them–if they are aware of their existence at all. “This is a good tool, but not one that is widely understood,” observes Terry Callahan, president of the Credit Research Foundation. “A CFO is more likely to understand the concept than a typical credit manager or insurance manager, but I’m not sure the buzz about this product is even reaching a lot of CFOs.”
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