What is Hedging?

Blockchain is one of the most intriguing technologies to emerge in the past decade. And with blockchain projects making headlines daily, it’s no wonder why this technology has caught so many people’s attention.

What is Blockchain?

In a nutshell, blockchain can be summed up as a constantly growing list of linked and secured records using cryptography. Each record stores information about transactions or any other data that can be stored in digital form. Each “block” is added to the chain of records and creates an encrypted link to all previous blocks (hence its name). In this way, the records cannot be altered retroactively. This is why blockchain technology is ideal for recording transactions or data that requires a publicly available log.

While the capability for blockchain to be used in so many different areas is clear, using it and being able to understand what’s going on may not be as evident. For example, we recently saw a vulnerability in the Ethereum (platform) wallet’s Parity. This vulnerability had been known about and fixed before, but a developer didn’t switch his wallet to the new updates immediately.

What is Hedging?

Hedging is the process of reducing your risk in investment by another investment. It is when you take action in one economic situation to balance out the negative effects of another action. Hedging is done by a company speculating on future market events.

Hedging with options, for example, is one way to make investment less risky. The most common way is to buy a call option when the investor feels that the price of an asset is going to rise. When that asset’s price increases, the option’s value will also rise. Conversely, if the price falls, it’s possible for the investor to sell his options for a profit before buying them at full price. Hedging with options also makes it possible to take advantage of discrepancies in price. In the case of an asset on a steady incline, it can be worth buying a put option at a lower amount of money than would be the case if the asset were steady.

Purpose of Hedging

The idea behind hedging is that it removes most of the risks of any investment. However, there are some instances when hedging can increase the risks associated with any given investment instead. For example, if a company or investor has just made a risky stock purchase and wants to minimize the risk that comes with it, they can hedge their position by buying put options on the same stock. If the stock price falls, the stock price will fall along with the put option price. If it rises, the put option can be bought at a much lower cost and sold for a much higher price.

A company looking to hedge its investment can use options, forwards, futures, and swaps. Options are contracts that give buyers the right but not the obligation to buy or sell an asset at a predetermined price on or before a specific date. Forwards are similar to options, but they must be settled on the same day their buyers bought them. Futures are financial instruments similar to options, but they occur through exchanges and settlements on specific dates in future months.

It’s important to note that there are different forms of hedges and that each one has its advantages and disadvantages. Below, we will present the most popular types of hedges: futures, forwards, options, swaps, and foreign exchange.

Types of Hedges

Futures

A future is a contract in which two parties exchange cash flows at a specified price on a specified date. This is called a forward contract. It’s also possible to buy or sell an option attached to a forward contract – a futures option.

Forwards

A forward contract is an agreement between two parties to exchange a specific amount of cash for a given asset at a specified price in the future. The seller agrees to buy the asset at that price, and the buyer agrees to sell it. This is often used for oil or currency transactions.

Options

An option gives the buyer the right, but not the obligation, to buy or sell an asset by a specific date at a predetermined price. This means if you think that the bitcoin price will increase, you can buy the call option to benefit from this situation. The downside is that if the buyer doesn’t exercise the call option will be limited to the cost of buying at that time.

Swaps

A swap is a contract where one party agrees to exchange cash flows with another. It’s like an insurance policy. In many cases, it will be similar to an option. But at other times it may not be identical since options are written on existing contracts. In contrast, swaps are entered into for better managing risk.

Foreign Exchange

This is a particular form of swap where you have access to fixed and floating rate payments depending on your trading and which currency you’re trading out with.

Final Words

It’s essential always to be cautious with your decisions and choices when it comes to investing. Always do your research on different companies and their market values. And don’t forget their growth projections and changing trends before making any investment decisions. Also, take into account your time horizon. There might be a case when your choice of investment is not at all beneficial to you. This is why some investors choose to gamble on the markets instead.

It’s also important to know that, as investors get older, they start trying harder to control their investments by pushing them into different asset classes, which skew the ratios. This means a valuable portfolio for younger investors might not be helpful for older ones. In other words, non-disabled investors need to consider how long-term gains will counterbalance longer-term losses.

Our commitment to delivering trustworthy and engaging content is at the heart of what we do. Each fact on our site is contributed by real users like you, bringing a wealth of diverse insights and information. To ensure the highest standards of accuracy and reliability, our dedicated editors meticulously review each submission. This process guarantees that the facts we share are not only fascinating but also credible. Trust in our commitment to quality and authenticity as you explore and learn with us.