What is the concept of hedging?

Hedging is designed to protect the share value from market volatility. In simple words, it acts like an insurance coverage which protects you from any potential loss.

The main purpose of hedging is to minimise/eliminate risk by offsetting the potential losses. Investors follow this to safeguard their investments from losses due to market volatility. Hedging is also done in areas like commodities, securities, currencies etc.

Types

The types of hedging include −

• Forward contracts
• Future contracts
• Money markets

Strategies

The various strategies to mitigate losses are as follows −

• Asset allocation − Portfolio diversification.
• Structure − Some part is invested in portfolio and some in derivatives.
• Through options − Options of call and puts of assets.

Strategy benefits are divided into long term and short term categories.

Long term strategy benefit

• Secure against price increase (if any).
• Provides protection.
• Floor price is locked.

Short term strategy benefit

• Reduces risk.
• Price lock.
• Helps in keeping desired rate of sale.

Advantages

The advantages of hedging are as follows −

• Profit locking.

• Traders can survive in tough marketing times.

• Loss is limited.

• Increase in liquidity.

• Saves time by adjusting daily market volatility.

• Offers flexible prices.

• Protects against price change, inflation, interest rates etc.

• Traders can go for complex options and get maximum returns.

• Investors can invest in various asset classes.