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Implementation Through Hedging: Taking the Sting Out of the Market Volatility

While the stock market remains highly volatile, even fixed-income instruments are susceptible to the changes in the economic conditions as the interest rates keep changing.

Powerful implementation strategies for financial management can offer investors a way to safeguard their investments against market volatility. Market risks such as equity risks, interest rate risks, currency risks, and commodity risks make an investor’s investments prone to market fluctuations. That’s where hedging comes into play that can reduce your risk of loss to a greater extent by making an opposite move in a different market.

Hedging means taking a position in a financial instrument (e.g., options, forward contracts, etc.) to offset the risks and losses that prevail in the cash market (stock market). In hedging, an investor takes an opposite action (i.e. if he bought shares in stock market, he will short-sell options as part of hedging strategy).

Market fluctuations are inevitable and to avoid its negative consequences, businesses need a strong implementation strategy that drives uninterrupted flow of returns through their investments with the help of hedging with financial instruments.

With hedging, investor’s chance of losing a great amount of money reduces significantly since if he loses money in the stock market, through hedging he can reduce the extent of loss by investing in put option of the same stock. It means although he loses money in stock market, he will gain money in the financial instruments market. And, the net effect will offset the loss.

The same theory applies to making profits, if an investor makes a huge profit in stock market, if he hedged that stock through financial instrument, he will make money in stock market but he will lose money in hedging and the net profit will be less.

Thus, a prudent strategy can be to hedge only those stocks that are highly prone to market volatility and hedging can support investors reduce the intensity of the losses and protect their investments against the market risks.