Hedging

In English parlance, ‘hedging’ typically refers to statements made to qualify or modify a more extreme position or opinion. Hedging in the financial or investment sense is pretty much the same thing (i.e., covering your butt) but the way in which it occurs is what’s confusing.

So I’ll go over the simple part first. So, you want to invest. Maybe it’s in a stock, or even in a group of stocks, that you think will rise in price. Pretty simple, right? But, what if the market does poorly? What if there’s a universal market crash? How do you protect that investment? The answer is a hedge. A hedge is an investment you make as a protection against risk. Wikipedia has a really good example of how the actual investment might look and perform over a few days, so I won’t bother to re-describe that here. What I will mention is a bit about how the complexity of a hedge works.

A hedge is typically a ‘shorting’ of a stock, meaning a contract for the rights to stock shares in the short term. It could be a swap, an option, or a future, or some other kind of right, but it is often not the actual physical exchange of stocks. Let’s look at an example. You think F industry, of which B stock is a part, is going to do poorly. Or you just think B stock is going to do not-so-well. You would take a short position of this stock, borrowing the stock and selling it at its current market price. Then, at a predetermined or optional future date, you buy the shares back, hopefully at a lower price, and return them to the lender. If the shares of stock actually fell in value, you’ve made a profit.

The question then comes up as to what the lender of the short has gained. Probably there was some sort of money exchanged for the rights to the stock for that period of time, either a percentage or some other exchange. I’m not sure exactly how that technically works yet. Also, I’m not sure I need to. Right now I’m going to go ‘hedge my bets’ that I don’t need to know.

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