Building an investment portfolio is a key aspect to protecting yourself against the wild swings of market volatility that may affect one or two assets. In developing a proper investment portfolio, you’ll also want to explore the possibility of hedging specific portions of your investments, or the common practice of “selective hedging”.
What is a Selective Hedging?
Selective hedging is the practice of investing in financial instruments that gain in the event of a loss in the primary investment asset. Often selective hedging is done by gold mining firms and other similar industries that have specific advantage information that can help them lessen the loss on a certain asset through investments in derivatives that payout when the main asset lowers in price.
Despite being more prevalent within firms, individuals can take advantage of selective hedging practices to reduce the risk on their own investment portfolios by applying the same practices in their investment choices.
How to Build Your Own Selective Hedging Portfolio?
To build a portfolio with selective hedges, you’ll first need to identify which one of your assets you’ll want to reduce your potential loss in. You can execute this hedge through various means, but the most common ways available to individual investors would be through derivatives such as put options and futures contracts.
When purchasing a specific asset, such as equity in a company, you can opt to purchase a corresponding put option alongside it to lower your loss. If the price of the asset you purchased continues to rise, you’ll just need to pay out the premium on the option. If the price goes below your “strike price” (your put option price), you can opt to sell your shares then at your set strike price to minimize your losses on the lower asset value. You can essentially do this same strategy for different assets you find in your portfolio that remains relatively “risky”.
Effectivity of Selective Hedging
It’s important to understand that hedging is primarily a tool used to reduce the potential loss on an investment. This also means that your potential profit is not maximized due to the underlying hedge you have against it. Moreover, you still need to pay the premiums that arise from purchasing derivatives, whether it be premium contract fees or other types of costs.
Selective hedging can be very useful for short-term investment bets on highly volatile assets but lose its value on longer-term investments by decreasing your overall return over the same time frame.
It’s important to conduct your own research into your specific investments to properly understand which strategy would work best for you. Selective Hedging remains a powerful strategy to use in loss mitigation, and should be kept in your tool belt should the need arise.
Note: Please do not invest money or assets in the financial markets that you cannot afford to lose. This article should not be construed to be investment advice and is for information purposes only.