The primary aim for hedging is protecting your investment against risk in the financial markets. It insulates your portfolio from making losses or profits whatever the circumstances may be affecting the instruments of your choice.
Interestingly, hedging gives you a level playing field when investing in the financial markets. It ensures your portfolio can recover from losses caused by the market’s downward trend. Your portfolio hedge strategy can offset losses if you decide to take two opposite positions on an investment derivative and walk away with either profits or a small margin in losses, with equal exposure to risk on your portfolio.
Of note, there’s a misconception about hedging and insurance that you should know before risking your portfolio. Unlike insurance, hedging doesn’t protect your portfolio from risks in the financial markets, and you cannot get compensation for losses suffered.
It’s prudent to consult your portfolio managers to enlighten you about the best hedging practices or click for more info on the benefits of using a hedge in your investment journey.
In addition, you need to understand risk against your portfolio to develop a hedging strategy to safeguard it if the market value of the underlying asset crashes. Some methods focus on specific risks in the market, whereas others cover a wide range of risks.
Here’s how to hedge your investment portfolio.
- Put Option
Due to the risks your portfolio might be facing, using the put option might be the right hedge strategy to deploy. Your investment will deal with the price index in your contract, and it can ensure that the outcome of market volatility favors you.
A put option is not a complex strategy, but it can be expensive considering the execution cost before or after the due date. Your portfolio manager can recommend specific asset classes to hedge by speculating the expected outcome. You’ll decide if your portfolio is worth using put options hedge strategy by looking at the underlying risk and your assets.
- Collar Your Portfolio
Before committing your portfolio, hedging requires thorough market analysis and identifying the strike price. A strike price is a predetermined price of underlying assets in securities exchanges. It offers a trade-off exchange that protects you from suffering huge losses at the end of the contract.
When you deploy collar to hedge your investment portfolio, you’re risking trading put option and call option to offset another. You’ll partly pay the put option cost by selling the call option, which may depend on the index. Those conditions will protect you when the market is on a downward trend since the upside is capped to cover losses.
- Diversify Your Investment
Diversification is equivalent to spreading your exposure risk and may reduce the impact on your portfolio should the market value of your underlying collapse. Having correlated instruments in your portfolio exposes your investment to equal risks and can shake your financial position.
Therefore, diversify your investments and explore more avenues to safeguard your portfolio. You must endure the hedging process to realize the long-term growth of your portfolio. However, hedging’s primary goal is offsetting losses and protecting your account from further losses. Your hedge managers can advise on long or short positions available in the market to realize profits.
- Futures Contract Strategy
Perhaps the most straightforward hedging instrument is using a futures contract strategy. Futures contract looks to lock the price of the underlying assets and expiry dates to execute the agreement.
The market value of your portfolio might change due to price action volatility, but the futures contract still holds the terms agreed upon in the initial agreement.
For instance, your futures contract can state that you’ll buy or sell a commodity or security at a predetermined price. Whatever price fluctuations might happen in the market, you’ll either be in the money or out depending on which side of the strike price your portfolio lies in the market.
- Use Leveraged Instruments
Leveraged instruments aren’t capital intensive and may work in your favor during volatility in the market. You can add uncorrelated assets to your portfolio and hedge for profits when the financial markets open.
If the market is bearish, you can inversely open a bullish position and trail the market price action. However, the market can move against your speculation and start making losses. Your stop loss can come to your rescue and exit the training position.
The price action of leveraged instruments moving very fast can equally empty your accounts without warning. You need to learn how this new method works before implementing it in your investments.
Hedging provides a safety net for your investment portfolio and can handle various risks in the trading markets. To determine which investment and hedge strategies suit your risk appetite, you need to evaluate your portfolio goals. However, it’s wise to consult your hedge managers to expound on the best approach to implement hedging in your investment portfolio.