Hedging with Options

Learn how hedging with options can be a useful tool to protect stock you may own

Introduction Articles

What are Options?
1 year(s) ago
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Call Options
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Put Options
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Strike Price
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Options Pricing
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Bid and Ask Price
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Hedging with Options
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Covered Calls
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Protective Put
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Options Assignment
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Why is Hedging with Options Useful?

Hedging can be a useful tool in your investment toolkit. It is used to reduce exposure to risk if an asset held in your portfolio may be subject to a sudden negative price move. When performed properly, hedging strategies reduce uncertainty and limit losses without significantly reducing the potential rate of return.

Commonly, a hedge would perform inversely to the vulnerable underlying asset an investor is trying to protect. In the event of a negative price move in the asset, the hedge should move in the opposite direction, counteracting any losses. 

Options can be used effectively as a hedge. A put option gives you the right to sell a stock at a certain price if the underlying asset begins to move lower. 

An Example of Hedging with Options

Let’s consider an existing position in XYZ PLC Stock which was purchased at 405.

The investor feels that the stock may move lower due to market conditions and thus wants to protect themselves from any adverse move.

The current market price of XYZ is 395 so the investor buys a 370 put in the market as a hedge. A negative news article is released regarding XYZ and the stock tumbles to 280. 

The investor now has the option to exercise their right to sell their position of XYZ at 370, significantly higher than the prevailing market price of 280; or simply to sell the option and use the profits to counteract the move in the stock. 

This is a common use of options for protecting a portfolio. See Protective Put for more detail.

Important information: Derivative products are considerably higher risk and more complex than more conventional investments, come with a high risk of losing money rapidly due to leverage and are not, therefore, suitable for everyone. Our website offers information about trading in derivative products, but not personal advice. If you’re not sure whether trading in derivative products is right for you, you should contact an independent financial adviser. For more information, please read our Important Derivative Product Trading Notes.

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