Hedging

Hedging is the practice of taking an offsetting position to protect against potential losses. Think of it as insurance for your investments — you pay a cost to limit your downside.

Common Hedging Strategies:

Strategy	How It Works	Cost	Protection Level
Put Options	Buy right to sell at set price	Premium paid	Strong downside protection
Inverse ETFs	Profit when market falls	Expense ratio + decay	Short-term protection
Collar Strategy	Buy put + sell call	Low/zero cost	Capped upside + downside
Diversification	Uncorrelated assets	Opportunity cost	Moderate protection
Stop-Loss Orders	Auto-sell at price level	Execution risk	Basic protection

Hedging with Put Options:

• Buy a put option on stock you own
• If stock falls below strike price, put gains offset stock losses
• Cost: option premium (typically 2-5% of position value annually)

Example: You own 100 shares of Stock XYZ at $100 ($10,000 position):

• Buy 1 put option at $95 strike for $3/share ($300 cost)
• Maximum loss: $500 (stock drops to $95) + $300 (premium) = $800 (8%)
• Without hedge: potential loss is unlimited downside

When to Hedge:

• Concentrated positions you can't sell (tax reasons)
• Before earnings announcements or major events
• When portfolio has reached a significant milestone
• During periods of extreme market uncertainty

Hedging Trade-offs:

• Reduces potential gains along with losses
• Costs money (premiums, spreads)
• Requires monitoring and adjustment
• Over-hedging can eliminate returns entirely