By Kristin Hovencamp
Weather forecasters are predicting a 60% chance of rain. In other words, it may rain, and it may not rain. By acknowledging there could be more than one possible outcome, the forecasters are hedging their bets. As an investor, if you are concerned about adverse price movements in the markets, hedge your investment bets. Portfolio hedging aims to limit or transfer risk in financial assets.
A derivatives trader once described a hedging strategy as, if you think it might rain, buy an umbrella. If you think the market might turn, buy protection. A hedge consists of taking an opposite or offsetting position in a security related to an existing position. Hedging is generally accomplished using securities, options, swaps, futures, and forward contacts.
Hedging can be deployed to help reduce investment risk. Imagine you own a long position in security “A,” and you are speculating “A” might not meet its projected quarterly earnings. However, you believe “A” is a valuable long-term investment. To help protect against a near-term decline in the price, you can hedge your bet by selling “A” short.
Investors can also hedge equity sector risk by taking an offsetting position in a security that is correlated to security A.
Hedging is often used to diversify portfolio risk. If your portfolio has a heavy concentration of equity exposure and inflation is a concern, you might buy Treasury Inflation Protection Securities (TIPS) to help protect against inflation.
Holding an offsetting position will not curtail you from losing money, but the possible gains from one security could help reduce losses in another security. Keep in mind that “Many financial disasters can be traced back to people who thought they were hedging,” —Aaron Brown.
Kristin Hovencamp is an Investment Executive at RJFS, and Director of Business Development with HAZLETT WEALTH MANAGEMENT, LLC, which is independent of Raymond James and is not a registered broker/dealer. Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance may not be indicative of future results. Some strategies may not be appropriate for all investors. Contact a qualified professional regarding your situation before making any investments. 675 Sun Valley Road, Suite J1 + J2 Ketchum, Idaho 83340 208.726.0605. HazlettWealthManagement.com