Hedging
Opening an offsetting position to reduce the net risk of an existing trade or portfolio against adverse price movements.
Hedging reduces exposure by taking a position that moves in the opposite direction to an existing holding. It does not eliminate risk — it transfers or reduces it, usually at a cost (spread, premium, or foregone upside).
Common hedging instruments include put options, inverse ETFs, short futures contracts, and correlated-asset positions. Traders hedge when they want to hold a long-term position through a period of expected short-term volatility without closing the original trade.
Example
Long 500 shares of SPY. As earnings season approaches, buy SPY put options to limit downside. If SPY falls 5%, the puts gain value and partially offset the loss on the stock.
Related Terms
Beta
A measure of a stock's volatility relative to the market. Beta > 1 means it moves more than the index; Beta < 1 means it moves less.
IntermediateBlack Swan
An extreme, unpredictable, high-impact event that falls outside the range of normal expectations and is rationalised as predictable only in hindsight.
IntermediateCorrelation
A measure of how closely two assets move together, ranging from −1 (perfectly opposite) to +1 (perfectly in sync).
IntermediateSwap
An OTC derivative in which two parties exchange streams of cash flows over time, such as fixed-for-floating interest payments.
AdvancedSystematic Risk
Risk that affects the entire market or a broad asset class and cannot be eliminated through diversification.
IntermediateTail Risk
The risk of rare, extreme outcomes in the far ends of a return distribution — events that standard models greatly underestimate.
AdvancedUnsystematic Risk
Company- or sector-specific risk that can be reduced through diversification across uncorrelated assets.
IntermediateValue at Risk (VaR)
The maximum loss not expected to be exceeded over a given time horizon at a chosen confidence level, e.g. 95% or 99%.
Advanced