Every investment comes with some inherent risk. Every investor must have strategies to reduce this risk and increase profits as much as possible. A common one is hedging. There are several ways and options to hedge against risk, one of them being options.
How Hedging Works
Hedging is a common strategy that entails opening one or more positions to help reduce the risk of an existing trade. The hedge could be a derivative trade, another investment, and in this case, an options position.
This strategy acknowledges that having zero risk in an investment is impossible, but that one position making a profit will offset the loss from another. This creates a net-zero or profitable situation.
Put and Call Options
Before looking at specific strategies, it is crucial to understand put and call options. Buying a call option allows a trader to purchase an asset, but not the obligation to. You should purchase a call option if you think the asset’s price will increase from its current level. Alternatively, if you predict the price will decrease, consider selling a call option.
With put options, you have the right to sell an underlying asset on or before the expiry date but are not obligated to. Buying is advantageous if you anticipate a decrease in the asset’s price. If you expect an increase in the market price, you should sell a put option.
Hedging Using Both Options
Since you profit from a put option if the asset’s price is below the strike (pre-determined) price, you can buy a call option and a put option on an asset you are bullish on. If the value increases, you execute the call but not the put, and vice versa. Even if you make a loss on premium (price paid to buy the option) by not executing one of these contracts, you still have an upside.
Finding an option that will be profitable on either end when you use this strategy is much easier with the help of an options analyst. They can teach you strategies that make choosing and knowing when to enter and exit positions much easier. By learning both, you minimize risk and increase the likelihood of profitable return.
Using a Protective Put
If you already own an asset such as a stock or gold and are bearish on it, meaning you think its price might decrease, you can buy a put option on it. If its value decreases, the value of the option will increase. Such an increase might offset some or all of the loss from a fall in the asset’s price.
If its price increases, you can choose not to execute and lose your premium. However, the asset’s price increase might be sufficient to cover this loss.
Hedging using options has many benefits, including reducing risk, increasing flexibility, and enhancing profitability. However, you should learn how to do it right, know which options and underlying assets to trade, and when to execute traders. Also, consider working with or learning from an experienced options trader to ensure success when you use your strategy.
