Thread: How do you make money by hedging?

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  1. #1

    Default How do you make money by hedging?

    I don't quite understand the strategy of "Hedging".

    In general, I understand what "hedge" means. A reduction or elimination of risks. I understand if I have a house, or a car, I should buy insurance in the event of theft and fire, it will protect me from a total loss. So longing a stock and buying call options to cover the entire holding, so that if the market goes down I can limit my risk by paying a little premium.

    I can understand hedging as a protection. What I don't understand is how you can use hedging to make money. In another thread, we talked about hedging the automotive stocks: long GM and short F or vice versa.

    If I have a perfect hedge, shouldn't I be at a neutral bouyance? e.g. I long SPY and short DIA with a equal ratio spread. So no matter whichever way the market moves, I will be okay. But the big question is: Why do you do it? How can you make money when you are perfectly hedged?

    So my question is: How do you make money by hedging?
  2. #2


    Without trying to sound overly simplistic (because I"m no expert) it's called arbitrage;
  3. #3


    My long strangle strategy thread that netwrangler and I elaborated on: link
  4. #4


    You don't necessarily, imagine you have $100million of Apple shares. You bought share and thus you are said to be "long". If you were to engage in transactions to protect that $100Million you would actually cause a change in the price, you can't move in and out of the position quickly. If you are scared that apple might come out with bad sales number for the iphone you could buy your self some put options to protect yourself incase they do. The put options act as a hedge against downside risk, allowing you to stay "long" $100Million worth of Apple shares while not having to worry about a short term loss due to the fluctuations in the price from the iphone news. If apple does not go down you end up just losing the premium you paid for the puts.
  5. #5


    Best example I can give you is what I have done with FXI and FXP for close to 13+ months now.

    FXP is extremely volatile due to its 2x Inverse status.

    I hedge the loss of one FXP with the amount of FXI I hold as a counter part. In some instances I have had to own 9 FXI to 1 FXP to neutralize a downfall in FXP or FXI for example. But that is a NEUTRAL Hedge - money made on one side barely covers the loss on the other side.

    So now comes - DOUBLE Hedging, holding both still FXI and FXP, what I will do is Sell Covered Call for FXI into 2 months ahead. For example after Option expiry in October I would sell Covered Call on FXI for December and generally speaking at a strike price of roughly $5.00 above my cost, and obtain roughly a $2.00 premium per contract.

    This provides me with some revenue to protect against a downside of roughly $2,00 and hopefully 2 months forward a gain of $5.00 per share if it gets Called on me, and I also bagged the $2.00 premium for the Contract.

    Ideally the share price rose $4.75, I got a nice boost in share price - bagged the premium , kept the shares and get to do it again for the following 2 months ahead!! :biggrin:

    FXP I do the exact same thing, except due to its volatility ( fun play this one with Call Options and PUTS, nice premiums ), I will sell contracts into the ongoing month, and at a strike of roughly 20 points ahead for a premium of $? $10.00 per contract. In short if my AVG is $55.00 I will sell a Covered Call at a strike of $75.00 for the ongoing month and obtain an $8 to $10 premium depending when I sold.

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