Traders in the stock market have different objectives. Some of the most important objectives are making profits in the long term, getting frequent gains in the short term, and protecting your investments in the stocks from extensive losses in the future.
Published on 17 March 2022
OPEN A FREE* DEMAT AND TRADING ACCOUNT
IN 15 MINS*
Hedging is a financial tool that helps you achieve the third objective. It is a risk management strategy that reduces the effect of uncertainties on your investments. In a way, it restricts the losses that result from fluctuating price movements of the stock.
Let us get into the details for a better understanding on hedging in the stock market.
What is Hedging?
Hedging can be defined as a financial tool which is a risk management strategy that you can utilise to offset losses in your current asset by taking a position in a related asset. The additional position provides a compensating gain when the actual position starts making a loss.
Two important pointers in hedging:
Hedging comes at a premium cost.
Hedge can help you prevent future damage but cannot erase or undo the previous damage.
Hedging is predominantly employed by the Indian equity and futures and options participants.
Let us consider a simple example.
Ram decides to buy a particular stock. He expects the stock price to rise and wants to take a position to reduce the loss in case the prices fall.
He can hedge that risk by engaging in a put option. He can purchase a put option at a cost that will give him the right to sell the stock at the same price. Then, if the stock price falls, he can exercise the put option to get back the money he had invested, subtracting the cost of the purchased put option.
Types of Hedging
Hedging as a risk management tool is utilised in the following areas:
Currencies that include various foreign currencies that might get affected due to volatility or currency risk.
Interest rates include lending and borrowing rates.
Hedging can be exercised in the derivative market that includes the forward contract, futures contract, etc., and the money market that involves short-term buying and selling, lending, borrowing, etc.
How Can Hedging be Exercised in the Stock Market?
The put option that we had discussed earlier will rise in value if the stock you have purchased falls in price. And if the value of the underlying asset rises, the put option will fall in value. The maximum loss, in any case, is the amount spent on purchasing the put option. And, the premium will certainly be a small portion of the purchased stock.
Hedging in the share market to minise risk can happen at three different stages.
1. At the time of purchasing the stock
When you are skeptical of purchasing a stock, you can initiate the trade with a hedge. In such cases, with the confidence of facing a downside by the offsetting position of the purchased hedge, you can buy the stock with satisfaction.
2. After purchasing the stock
You have purchased a stock and find the prices tend to fall. In such cases, you can utilise the hedging strategy as you near the stop loss level, beyond which you cannot afford to lose any amount by purchasing a put option at a premium.
3. When the purchased stock makes a profit
You have purchased a stock and find the prices keep increasing. Immediately, you tend to be skeptical whether to sell the stock at the current price and book the profit or hold it for a while to further the gains. In such cases, you can buy a put option and lock the profit with a hedging strategy.
Advantages of Hedging
Hedging can be a beneficial tool considering the following advantages.
A hedge can protect your capital from adverse events that lead to extreme losses. For example, a black swan event can cause massive destruction to the financial markets. With a hedging strategy employed smartly, you can prevent such events from causing excessive damage to your investments.
Traders having a low-risk appetite can trade in the stock market using the hedging tool and stay at peace.
Helps traders diversify the portfolio, increasing liquidity.
Saves time required to keep monitoring the prices. Also Read: Portfolio Investment
Disadvantages of Hedging
While hedging can protect you from potential risks, it has to be exercised with caution.
Hedging can drag your profits if it is bound to occur. If you lock your profit at a certain point and the prices go up further, you lose the actual profit.
The purchase of the stock and the hedge have transaction costs. If you have not done effective research on the cost of purchasing in detail, you might incur high transaction costs.
Conclusion
Hedging is a financial tool that helps you reduce losses due to unexpected events in the stock market. It is an effective risk management tool that comes at a premium cost. You can utilise it while initiating the trade, after purchasing the stock to protect it from losses or after the profits start incurring to lock it after a certain extent. Research the different options and use the hedging tool to minimise risk effectively!
Team Espresso
We care that you succeed
Bringing readers the latest happenings from the world of Trading and Investments specifically and Finance in general.
Futures refer to derivative contracts that obligate the buyer and the seller to transact a stock, security, or commodity at an agreed-upon future price and date. It is also known as futures contracts. The agreements are legally binding. On expiry, it must be settled either in cash or by physical delivery.
Trading and investing are two financial practises that have been gaining importance globally. These are considered some of the best ways to grow your wealth. However, there are different methods to trade and earn profits.
Forward contract and futures contract are two financial contracts that may seem pretty similar to one another. However, being a novice in trading, you need to know that there are quite a lot of differences between the two.
Companies can enter into futures contracts to protect themselves against extensive risks. For example, they can purchase a futures contract to lock the prices of raw materials that might increase in the future.
Three types of hedging are used in the stock market: the Forward Contracts, the Futures Contract, and the Money Market.
A hedge fund refers to a pool of money that buys and sells equities, takes both short and long positions, trades bonds, currencies, etc., at reduced risk. Hedge funds protect investors' capital against market volatility by exercising various strategies.
Traders can hedge investments by:
Structuring - It means investing a portion in debt and the rest in derivatives. The debt investment ensures security and stability while the derivative investment protects from potential risks.
Options - Options include the call and put option to secure your portfolio when invested appropriately.
Asset allocation - Broadening the investment strategy by purchasing different classes of assets to balance the profits and losses.
Related Articles
What Are Futures Contract?
Futures refer to derivative contracts that obligate the buyer and the seller to transact a stock, security, or commodity at an agreed-upon future price and date. It is also known as futures contracts. The agreements are legally binding. On expiry, it must be settled either in cash or by physical delivery.
Trading and investing are two financial practises that have been gaining importance globally. These are considered some of the best ways to grow your wealth. However, there are different methods to trade and earn profits.
Forward contract and futures contract are two financial contracts that may seem pretty similar to one another. However, being a novice in trading, you need to know that there are quite a lot of differences between the two.
Companies can enter into futures contracts to protect themselves against extensive risks. For example, they can purchase a futures contract to lock the prices of raw materials that might increase in the future.
Three types of hedging are used in the stock market: the Forward Contracts, the Futures Contract, and the Money Market.
A hedge fund refers to a pool of money that buys and sells equities, takes both short and long positions, trades bonds, currencies, etc., at reduced risk. Hedge funds protect investors' capital against market volatility by exercising various strategies.
Traders can hedge investments by:
Structuring - It means investing a portion in debt and the rest in derivatives. The debt investment ensures security and stability while the derivative investment protects from potential risks.
Options - Options include the call and put option to secure your portfolio when invested appropriately.
Asset allocation - Broadening the investment strategy by purchasing different classes of assets to balance the profits and losses.
Sharekhan Comtrade Private Limited (TM) operates the web site accessible from the URL www.myespresso.com (the “web site”').
Sharekhan Comtrade Private Limited is committed to protecting your privacy and utilising technology that gives you the most powerful, safe, online experience that you can get anywhere else.
Sharekhan Comtrade Private Limited does, however, gather certain information that is provided by you to the Web Site. Sharekhan Comtrade Private Limited believes that by collecting this information Sharekhan Comtrade Private Limited is able to provide you with a personalised web experience, and to assist its own sales team and advertisers in efficiently reaching an appropriate audience.Sharekhan Comtrade Private Limited does, however, gather certain information that is provided by you to the Web Site. Sharekhan Comtrade Private Limited believes that by collecting this information Sharekhan Comtrade Private Limited is able to provide you with a personalised web experience, and to assist its own sales team and advertisers in efficiently reaching an appropriate audience.
Sharekhan Comtrade Private Limited requests the minimum information it believes necessary to achieve this goal.
The following discloses Sharekhan Comtrade Private Limited's information gathering and dissemination practices for the Web Site:
System Data:
Sharekhan Comtrade Private Limited uses your IP address to help diagnose problems with our server and to administer the web site. Your IP address is used to identify you and your shopping cart and to gather broad demographic information.
Registration Data:
The Web Site's registration form may require users to give us contact information (like their name, phone number and e-mail address), unique identifiers (like their PAN Number) and demographic information (like their pin code, age or income level). The Web Site uses customer contact information from the registration form to send the users information about Sharekhan Comtrade Private Limited and promotional material from some of Sharekhan Comtrade Private Limited's partners. The customer's contact information is also used to contact the visitor when necessary. Unique identifiers (such as PAN numbers) are collected to verify the user's identity. Demographic and profile data is also collected at the Web Site. We use this data to tailor the visitor's experience at the Web Site, showing them contents that we think they might be interested in, and displaying the contents according to their preferences. This information is shared with advertisers on an aggregate basis.
Links and Co-Branded Sites:
This site contains links to other Web Sites which are not necessarily been screened or reviewed by www.myespresso.com. Sharekhan Comtrade Private Limited is neither responsible for the privacy practices or the contents of such Web Sites nor shall be held answerable for the inaccurate, inappropriate or offensive data, material, information, products and services that may be viewed on those sites.
Sharekhan Comtrade Private Limited may operate a number of co-branded sites. Policies regarding information collection and sharing may differ on some of these co-branded sites. If you have any particular questions, you should check the privacy statement that appears on each co-branded site.
Order Forms:
The Web Site uses an order form for customers to request information, products and services. The Web Site collects visitors' contact information (like their mobile number or e-mail address), unique identifiers (like their PAN number) financial information (like their account or credit card numbers) and demographic information (like their pin code, age or income level). Contact information from the order form is used to send orders, information about Sharekhan Comtrade Private Limited, and promotional material from some of Sharekhan Comtrade Private Limited's partners to the visitors of the Web Site. The visitor's contact information is also used to get in touch with the visitor when necessary. Financial information that is collected is used to check the users' qualifications and bill the user for products and services. Unique identifiers (such as PAN numbers) are collected from Web Site visitors to verify the user's identity.
Surveys and Contests:
The Web Site's online surveys ask visitors for contact information (like their mobile number or e-mail address) and demographic information (like their pin code, gender, age or income level). The Web Site uses contact data from its surveys to send the user information about Sharekhan Comtrade Private Limited and promotional material from some of Sharekhan Ltd.'s partners. The customer's contact information is also used to contact the visitor when necessary. Users may opt-out of receiving future mailings; see the choice/opt-out section below. Demographic and profile data is also collected at the Web Site. The Web Site use this data to tailor its visitor's experience at the Web Site, showing them content that it thinks they might be interested in, and displaying the content according to their preferences. This information is shared with advertisers on an aggregate basis.
Sharekhan Comtrade Private Ltd run contests on the Web Site in which we ask visitors for contact information (like their e-mail address). Sharekhan Comtrade Private Limited uses contact data from its contests to send users information about Sharekhan Comtrade Private Ltd. and promotional material from some of our partners. The customer's contact information is also used to contact the visitor when necessary. Users may opt-out of receiving future mailings; see the choice/opt-out section below.
Third-Party Advertisement Servers:
Sharekhan Comtrade Private Limited engages the services of an outside advertisement company to display advertisement on the Web Site. These advertisements may contain cookies. While Sharekhan Comtrade Private Limited uses cookies in other parts of the Web Site, cookies received with banner advertisements are collected by the Advertisement company, and Sharekhan Comtrade Private Limited does not have access to this information.
Protection of your Data and Information:
The privacy and protection of your data and information provided to us is of vital importance. Sharekhan Comtrade Private Limited shall ensure to safeguard the security and confidentiality of any information you share with us. Any personally identifiable information of the customers obtained by us shall not be used or shared other than for the purposes to which the customers consents. However security and confidentiality of information cannot be guaranteed cent percent. Hence despite our utmost efforts to protect your personal information, Sharekhan Comtrade Private Limited and www.myespresso.com cannot warrant the security of any information you transmit to us through our online services. Such transmission of your personal information is done at your own risk.
Disclosure of Customer Information :
Sharekhan Comtrade Private Limited and www.myespresso.com shall not deliberately disclose customer's personally identifiable information to any unauthorized third person, save and except where such information shall be disclosed in good faith and for the purpose of law for the time being in force or to protect the rights and property of Sharekhan Comtrade Private Limited and www.myespresso.com.
Public Forums :
The Web Sites makes chat rooms, forums, message boards and/or news groups available to its users. Please remember that any information that is disclosed in these areas becomes public information and you should exercise caution when deciding to disclose your personal information.
Supplemental Information :
The Web Site supplements the information that you provide with information that is received from third parties.
The Web Site DOES NOT entice by the prospect of a special game, prize or other activity, to divulge more information than is needed to participate in the activity.
Further to the above, in light of the recently notified Information Technology (Reasonable security practices and procedures and sensitive personal data or information) Rules, 2011. (Hereinafter referred to as the Rules)
The following shall be deemed to be sensitive information :
Password;
Financial information such as Bank account or credit card or debit card or other payment instrument details;
Physical, physiological and mental health condition;
Sexual orientation;
Medical records and history;
Biometric information;
Any detail relating to the above clauses as provided to body corporate for providing service; and
Any of the information received under above clauses by body corporate for processing, stored or processed under lawful contract or otherwise:
provided that, any information that is freely available or accessible in public domain or furnished under the Right to Information Act, 2005 or any other law for the time being in force shall not be regarded as sensitive personal data or information for the purposes of Rules.
Collection of Information:
Compliance with KYC guidelines as per SEBI / Exchanges / Or any other Act, law or regulation requiring the same and any internal KYC guidelines formulated by Sharekhan Comtrade Private Limited.
In order to provide enhanced trading experience to the client.
In order to provide any further information to be provided to regulators.
Such information may be collected in a manner that the client is always aware of the collection and purported usage of the same. The client shall have an option to withdraw consent to share the information. However such intimation shall be required in writing. Such intimation shall only be taken into account from the date on which the same is received. Sharekhan Comtrade Private Limited may choose to stop services to such a client in case such intimation is received. Such information shall only be used for the purpose it is collected.
Clients would be allowed an option not to disclose any information to be collected, provided the same is in compliance with regulatory requirements.
Disclosure of information:
Disclosure of sensitive information would be as per the terms agreed by the clients. For any change in such terms, the clients would be informed.
Provided no consent may be required in case the same is being shared as per compliance guidelines or as required by regulators.
Any information being disclosed to third parties would be in accordance with the Rules and would be done provided such third party has the same level of compliance guidelines as Sharekhan Comtrade Private Limited.
Sharekhan Comtrade Private Limited shall allow clients to review their personal information and the same shall be allowed to be edited provided exchange guidelines relevant to the same are followed.
Sharekhan Comtrade Private Limited shall maintain reasonable security practices and procedures and maintain a comprehensive documented information security programme. In the event of an information security breach, Sharekhan Comtrade Private Limited or a person on its behalf shall be required to demonstrate as and when called upon to do so by the agency mandated under the law, that there have implemented security control measures as per their documented information security programme and information security policies and information security policies that contain managerial, technical, operational and physical security control measures that are commensurate with the information assets being protected with the nature of business.
KYC Languages
Download Client Registration Documents (Rights & Obligations, Risk Disclosure Document, Do's & Don't's) in Vernacular Language :
Note: "This document is a translated version of the client registration documents in English and is being provided in vernacular language to facilitate better understanding by the investors. In case of any ambiguity, the contents of the English version would prevail."
NDNCR Terms & Conditions
By accepting the Terms & Conditions, you authorise Espresso, its representatives and agents to provide information about various products, offers and services provided by Espresso through any mode, including telephone calls, SMSes, emails, letters and any other mode of communication. You also confirm that laws in relation to unsolicited communication referred in "National Do Not Call Registry" as laid down by "Telecom Regulatory Authority of India" will not be applicable for such information/communication.
Filing Complaints on SEBI Complaint Redress System (SCORES) - Easy and Quick
Register on the SCORES portal
Mandatory details for filing complaints on SCORES:
Name
PAN
Address
Mobile Number
Email ID
Benefits:
Effective communication
Speedy redressal of grievances
You can file complaints on SCORES through https://scores.gov.in/scores/Welcome.html