Saturday, February 15, 2014

Hedging is a good options strategy

How do you hedge a short stock position? Simply purchase a long call. By buying to open a call option on the stock you've shorted, you gain the right to purchase the stock at the strike price of the contract. For example, say you shorted Stock XYZ when it was trading at $30. The shares have since declined to $18, proving your theory correct. But, unfortunately, the equity surged to $24 after a positive earnings report, and your profits are dwindling rapidly.

In order to hedge your position, you could buy to open an out-of-the-money call option -- in this case, the $25 strike would work. Then, you could lock in a profit of $5 on the trade, because you've obtained the right to purchase the shares at $25 each. Even if XYZ rallies up to $32, which would have placed your unhedged short sale at a loss, you can still come out victorious. In summation, there's no limit to the number of ways you can hedge your bets with options. Be sure that you're not hedging when you should be closing out a losing position. It's always a good idea to re examine your thoughts for the trade, and make sure your trading plan is still sound. before choosing your next move.
How to hedge stocks