Hedging

• Hedging is one way to protect against the fluctuations and uncertainties inherent in the stock market, as well as other financial markets. Hedging is any strategy that uses financial instruments as a kind of insurance against drastic fluctuations, often by buying the right or opportunity to take an opposite position. While hedging can save investors from the worst drops, acquiring hedging instruments often costs extra money or involves also forgoing the possibility of high profits.
  
  

Stock Options

• Hedging in the stock market usually involves stock options. Commercial stock options share similarities with employee stock options because both are contracts that give the holder the right to buy shares at a set price at a later date. However, commercial options differ in that they can be to buy or sell shares and can be freely traded on exchanges. Options differ from futures in that futures require the holder to buy or sell on the stated date while option holders can simply let the option expire.
  
  

Puts

• Put options allow the holder to sell 100 shares at a specified price (the strike price) on a specified date. An investor with 100 shares who has some doubts about the market or a company can buy a put contract as a hedge. If the market price drops, the investor can sell at the strike price and not realize a loss The Motley Fool suggests an alternative hedging strategy of selling the put option at a profit and keeping the stock, if the investor believes the downturn to be temporary.
  
  

Calls

• Call options give the holder of the option the right to buy 100 shares at the strike price on a specified date. If an investor believes that a given share price will rise, but is unwilling to throw considerable money behind the hunch, the investor can buy a call option at a fraction of the price of the actual shares. If the price goes up, the investor realizes a profit minus the cost of the option, whereas if the price stays the same or drops, the speculative loss is minimized to the price of the option.