Tahoe-Truckee Market Beat: Hedging your investments good or bad?
Special to the Sun
The term “hedging your bets” has been in use for more than 500 years. The origins of the term are interesting; it goes back to the days when people would plant hedges around their property as a fence.
The hedge would define the area of the property, and the term began to be used to mean limited risk. The way the hedge limited the property area, an investment hedge would limit the risk you were exposed to.
Hedge funds have been around for many years and have become increasingly popular recently.
Hedge funds today employ a variety of strategies, and not all of them involve using hedges. One type of trading that the original hedge funds used was a market neutral strategy, where the fund would trade a pair of stocks.
They would make a long investment in one stock, then short a similar stock that is in the same sector, has a similar market cap and is from the same country.
Investors often ask me if there’s a way they can hedge their portfolios and the answer is yes, but like anything else, there are advantages and disadvantages.
One advantage of course, is that you can get some protection for your investments from a market decline. A disadvantage is that the protection comes with a cost.
By having a hedge in place, you’ll lower your upside returns in a bull market. Some investors may be better off to have a long-term investment horizon and be prepared to ride out the inevitable periods of high volatility that the market will go through at times.
Options can be good hedging tools. Put options can be purchased on individual stocks or exchange traded funds. By purchasing a put, you’ll know exactly what your worst-case scenario is for the position that you have protected.
When you purchase a put, it will give you the right to sell your stock at a specific price by a certain date. The price is known as the strike and the date is the expiration. The put option has a cost, which is also known as the premium.
There are also a variety of inverse ETFs available today. An inverse ETF will move in the opposite direction of the underlying index or sector that it represents and can provide a hedge.
All hedges come with a cost, and they may not be suitable for all investors.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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