4

Often, I would read about traders/investors hedging their position in case things do not go their way. I find this strange. If one were unsure, then wouldn't it be better to simply reduce the position size instead of taking on an opposite position?

  • Don't forget that you often hear about hedging in the futures market, and the agent hedging may be a company trying to guarantee itself a certain price (high or low) for a commodity in the future. They may not have a position in the commodity at the moment. – John Bensin Oct 7 '13 at 2:23
7

Sometimes you may want to be in a position long term but are worried about short term volatility and the price going against you in that period. You don't want to sell and re-buy back later as this may trigger a capital gain. Plus you don't know the extent of the price drop or when it will start recovering, so an alternative is to hedge against any potential short term weakness in prices but still reap the long term gains without triggering any intermittent capital gains.

  • 2
    The only thing I might add is that you might hedge because it is costly to get out of and back into the investment. Sometimes that's because of fees, other times taxes as you mention. – C. Ross Oct 6 '13 at 21:30
  • Yes if you have a full-fee broker it can become quite expensive. – Victor Oct 6 '13 at 21:32
2

A lot of hedges use a lot less capital than the core position uses, while still retaining the ability to reduce or eliminate losses. The core position is still being able to gain nearly as much as it could unhedged. If one simply reduced the core position size, then they really wouldn't be able to gain as much on their capital.

Think of hedges are insurance premiums, you pay a small amount to gain big in the case of an adverse scenario.

1

Say I have a portfolio of 50 well chosen stocks. Stocks that are 'guaranteed' to beat the market. But I think the entire market is in trouble. I place a short position on the S&P index. I'm right, the market drops, my 50, not as much, but they did go down. I was better off doing it this way than to sell my positions.

I also would have a tough time telling my shareholders why I just went to all cash. But this way I still add value.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.