What are Hedging Strategies?
Hedging is the practice of holding securities or investment positions in order to reduce damage that might be a result in a volatile market. There are many hedging strategies that an investor can use in order to reduce risk in volatile times. These Securities that offer hedge are securities that move against the current of the market trends. With that here are the most common hedging strategies that an investor may use.
Common Hedging Strategies
1) Calendar Spreads – this Strategy is created by investing into a long-term option that will replace a short-term put option with the same strike price. Calendar Spreads decrease cost of adding a few more months into a put option which will also create an opportunity to put a cheap hedge in place at a future date.
2) Put Rolling and Time Extension – this is a strategy where in an investor purchases the longest available put option. This is because marginal cost of each additional month generally has a lower strike price than the month before.
3) Spread Hedging - spread hedging is when the investor buys a position with a higher strike price and sells one that has a lower price with the same time expiration date. This provides investors with a limited protection, as the maximum payout from both positions will only be the difference between the two strike prices.
There are many more hedging strategies that are available for investors to choose from. But hedging in general has one goal that is to reduce the loss in times of volatility in the market.
Some investments are easier to hedge than others, more often, investments like broad investments are cheaper to hedge than individual stocks and lower volatility in the market makes the put option less expensive.