Top 5 Hedging Strategy in Options
If you are a trader who wants to increase his portfolio and earn some extra money through market movements, options trading can be a choice. For this, hedging strategies play an important role, especially for option trading beginners. Let’s explore the top 5 hedging strategies that can help mitigate risks and enhance profitability.
Top 5 Hedging Strategies
Here are the five most common hedging strategies.
1. Long Put
In the Long Put strategy, a trader purchases put options, granting them the right to sell the underlying asset at a predetermined price (the strike price) within a specified period. This strategy acts as insurance against potential downward price movements in the asset.
If the underlying asset’s price declines, the put option increases in value, offsetting losses in the trader’s portfolio.
It’s a straightforward approach commonly used by traders to hedge against market downturns and minimize potential losses.
2. Protective Put
The Protective Put strategy is buying put options for stocks that are already owned. The value of the put options increases in case the underlying stock prices go down, thereby reducing losses on a stock position.
When traders buy put options at a premium, they set up a bottom price point for which shares could be sold to reduce downside risk. Thus, it provides traders with an opportunity to protect against falling prices and profit from rising prices of stocks.
It is generally used as a measure to ensure that trade in shares survives during downturns or periods of uncertainty.
3. Covered Call
In this strategy, a trader already owns an asset and sells call options on it. By doing so, they receive a premium, which provides downside protection for the asset’s value up to the strike price of the calls.
If the asset’s price remains below the strike price, the traders keep the premium and maintain ownership.
However, if the price rises above the strike price, the trader may have to sell the underlying asset at that price, potentially missing out on further gains.
4. Straddle
A trader initiates a straddle by simultaneously purchasing a call option and a put option with the same expiration date and strike price for a particular underlying asset.
This strategy is deployed when anticipating significant price volatility but uncertain about the direction of movement. If the underlying asset’s price shifts significantly upward or downward, one of the options will become profitable, compensating for losses on the other option.
Straddles aim to capitalize on volatility rather than predicting market direction, offering potential gains in either scenario.
5. Butterfly Spread
The butterfly spread involves a trader buying one option, selling two options with a higher strike price, and buying another option with an even higher strike price, all with the same expiration date. This creates a net debit or credit, depending on the chosen strike prices.
The strategy profits if the underlying asset’s price remains within a narrow range upon expiration. It provides a limited-risk, limited-reward scenario and is used to hedge against significant price fluctuations or capitalize on minimal price movement.
Conclusion
Learning about hedging strategies in options trading is key to protecting your trades and making the most of potential gains. Don’t forget that even if you’re just starting out, you can navigate the market confidently with the right knowledge and tools. If you’re keen to learn more, check out option trading classes on Upsurge.club.
