A common example of this type of hedging is airlines that buy oil futures several months in advance. Airlines cover costs, to a large extent, in order to better budget for future expenses. Without the hedge, airline operators would be significantly exposed to the volatility of oil price changes. Hedging is a sophisticated risk management strategy.
In theory, they can limit the potential losses of an asset you own or limit the price of an asset you want to buy. Generally, if the value of your investment falls, the value of your coverage increases. If the value of your investment increases, the value of the hedge generally falls, so to speak. Options, which are contracts for the right to buy or sell a stock or other asset at a specified price and time, are often used as hedging strategies.
Hedging strategies are designed to reduce the impact of short-term corrections on asset prices. For example, if you wanted to hedge a long stock position, you could buy a put option or set up a guarantee for that stock. Portfolio managers, individual investors, and companies use hedging techniques to reduce their exposure to various risks. An example from everyday life is car insurance, which protects the driver against theft and accidents, among other risks.
A commercial hedge is a company or a producer of a product that uses derivative markets to cover its exposure in the market to the items it produces or to the inputs needed for those items. In the stock market, hedging is a way to protect the portfolio, and often, protection is just as important as the revaluation of the portfolio. A portfolio hedge would be considered effective if its value remains relatively stable in the face of falling asset prices. If you wanted to cover the capital part of your portfolio, you would have to cover all capital positions, which would be extremely expensive.
Others may think that establishing short-term coverage equates to timing the market and, therefore, may choose to focus on the long term. In the event that price movements favor the investor, the investor obtains all the profits from his original investment or position, but loses the premium paid for the option used to hedge his position. This can be done if hedging is no longer necessary, if the cost of hedging is too high, or if you are looking to take on the additional risk of an unhedged position. The examples provided are for illustrative purposes only and are not intended to reflect the results you can expect to obtain.
Technically, in order to protect yourself, it is necessary to carry out compensatory operations on securities with negative correlations. In the event of an unforeseen circumstance, a properly hedged position reduces the possible losses that could have occurred.
