Hedging is the technique used by market participants to prevent taking excessive risks and impose stringent risk controls. Options are used as hedging instruments to mitigate the risks of the underlying asset, however, hedging your existing option position can also be done using another derivative instrument or an investment.
A popular hedging strategy in option is delta hedging, and we will also look into popular delta hedging course to gain practical insights.
What is Hedging in Options?
Assume you have a stock market portfolio and the markets are a little jittery due to concerns like inflation, war, etc. The markets will be volatile and your investments are likely to decline. Here, you have the below options: a) Watch your investments decline, and wait for the reversal b) Sell your investments and book profits C) Hedge your portfolio
The last option will entail you taking a position opposite to your portfolio and protecting your portfolio from unusual market volatility. Sure, hedging has its own costs, but the benefits outweigh them if used efficiently.
There are various hedging techniques using different derivatives that we will discuss which might benefit you.
Hedging Your Options Portfolio
If you have taken a naked options position or an underlying position, options can be used effectively to hedge your portfolio. For instance, if you have gone long stock X, where you have set the target price. However, markets are volatile and you want to protect your downside, you simply buy put options on that stock.
Buying a put option means getting the right (but not obligation) to sell the underlying at a later date. It gains value if the stock price goes below the exercise price you choose and you hedge your risk.
If you already have an options position and want to hedge then you can either use futures or options to hedge your position. Popular strategies are: a) Straddle – Where you buy/sell an ATM call and put option to balance your portfolio, the market goes in either direction, and you stand to gain. B) Strangle – Where you buy/sell OTM call and put option to hedge your portfolio.
Putting it into Practice
There is more to hedging than meets the eye. We have discussed the most popular and basic strategies; however, you can use various other strategies based on your portfolio. One popular strategy is delta hedging where you offset the directional risk associated with the underlying. There are popular delta hedging course and option trading courses online to give you exposure.
Upsurge.club provides delta hedging as well as option trading courses where you will learn delta hedging in detail and other option trading strategies. The courses give you exposure to live market scenarios and teach you how hedging works by taking different combinations.
Conclusion
While hedging is used to mitigate the risks, it sometimes increases the risk in your portfolio if not used efficiently. Hedging must be undertaken at the overall portfolio level rather than at the individual asset level.
Just hedging the portfolio will not give you desired outcomes, you also have to adjust your hedge based on the market movements to maintain the appropriate risk level.