Financial Terms / G - H / Hedging

Hedging

Hedging is a risk-minimization strategy in which you try and offset your potential future losses by taking an opposite position in a related asset. In attempting to minimize risks by hedging your portfolio, you are somewhat protected from downside risks. However, this also limits upside potential.

For example, investors use index (SPY) put options (a financial derivative that increases in value if the underlying asset reduces in value) to hedge their exposure to investing in the index. If the market rises, you lose the money you paid for the options. However, if the market falls, your options increase in value, thus reducing the losses.