But occasionally markets experience bouts of extreme volatility and declines, which can wreak havoc on portfolios. After all, according to Warren Buffett, Rule No. There is truth in that.

First, real people are emotionally driven and occasionally irrational actors.

Are you in retirement? Look what happened to retirement plans during the several years of the financial crisis bear market. Third, distributing risk and having a solid floor is just good practice. Last, hedging can be considered as another method of diversification. So how does one hedge? There are many possibilities; each with pros and cons so there is no ideal strategy.

But here are some common approaches:. The most obvious strategy is to sell some equities and move to cash. However this is less a hedge and more nonparticipation.

Nobody ever got rich holding cash. Rotating into defensive sectors or assets such as consumer staples, utilities and bonds is another strategy. Similar to the cash option, this strategy is more a mix between tactical diversification and hedging rather than being a pure hedge. Moving on to more active hedges, the realm of hedging to protect or to profit from large declines. In many cases, leverage becomes important — but caveats abound.

Hedging in Options Trading - Explanation and How to Use

One active hedge strategy is buying inverse equities, i. Here, not only do you avoid market loss but you profit at a 1: The disadvantage is the protection effect is minimal — full equity protection requires a Another disadvantage is becoming exposed to losses if markets reverse and climb — a high risk if the timing is off.

Hedging - Using Covered Calls and Put Options to Hedge a Position | InvestorPlace

For moderately sophisticated investors, options are attractive hedges due to their leveraged nature, the ability to limit your exposure and their general versatility. The simplest option method is buying a protective put — essentially a bet the market will decline and getting paid for it.

The downside of course is that you may end up paying quite a bit, especially in times of volatility, for this protection — nothing is free. Another option strategy is writing calls; essentially the opposite of the put with your maximum upside being the value of the option. There are many more complicated hedging methods.

These, however, carry significantly more risks and should only be employed by those familiar with them. For the average investor, these five basic strategies can be used to help protect their portfolios from excessive losses. Each strategy carries pros and cons in timing risk, degree of downside coverage, ease of execution, capital outlay and probability of success.

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Hedging With Options

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Economy Federal Reserve Capitol Report Economic Report Columns Darrell Delamaide Rex Nutting Tools Economic Calendar. My MarketWatch Watchlist Alerts Games Log In. New York Markets After Hours Market Snapshot Winners and Losers. Zhang's Winner Take All Get email alerts. Protect your portfolio with these 5 basic hedging strategies. But here are some common approaches: Stay in cash The most obvious strategy is to sell some equities and move to cash.

Defensive rotation Rotating into defensive sectors or assets such as consumer staples, utilities and bonds is another strategy. Inverse equity returns One active hedge strategy is buying inverse equities, i. Option protective puts For moderately sophisticated investors, options are attractive hedges due to their leveraged nature, the ability to limit your exposure and their general versatility.

Option call writing Another option strategy is writing calls; essentially the opposite of the put with your maximum upside being the value of the option. APR Last Week 6 Months Low Interest We Want to Hear from You Share your strategies for protecting your portfolio in market downturns Comment.

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