How To Hedge – Taking Your Investing To The Next Level

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Hedging

A hedge is a position to reduce downside potential or loss. The best investers will always hedge their long-term positions when the market shows signs of uncertainty. Mark Cuban did this during the crash at the start of the pandemic in March 2020.

In stocks hedging is mainly done 2 ways…

1. Buying Market Inverse ETF’s

These are stocks/funds that go the opposite direction of the market. When the market is going down like we have been seeing, these stocks go up. Some examples are…

$SPXS- Goes the opposite of the S&P 500
$SQQQ- Goes Opposite of the NASDAQ

Buy and hold these for the time being, then sell when you think the time is right. Right now I would buy $SQQQ as the NASDAQ is getting hurt more than the S&P. Due to all of the tech & high growth stocks within the NASDAQ.

2. Buying Put Options On Stocks You Hold In Your Portfolio.

Put options are leverage contracts on certain stocks. Each contract you buy gives you exposure to selling 100 shares of stock at a certain price, without owning 100 shares. You pay a fraction of the cost it would be to own 100 shares, but only for a specified period of time. When you buy a put, you make money as the stock goes down.

Here is an option chain for Square ($SQ) with contracts expiring June 4th, 2021. I know it looks confusing but hear me out. There are only a few things that you must look for when buying put options for hedging. Puts are on the right side, calls are on the left.

  1. Strike Price
    This is the price you would agree to sell 100 shares of stock, if you were to exercise the contract. Don’t worry too much about what that means just yet. The lower you want to buy for a strike price, the cheaper the option contract. Because it is further away from the current share price of the stock. The goal for any option is for the current share price to reach the strike price before expiration.
  2. Bid vs. Ask
    The bid is the price you pay to buy the contract, the ask is the price you would sell at. The bid and ask are always the current number x100. In this case for the 190 strike put. You would pay $720 (7.20 x 100=720). The reason is you are paying for the right to 100 shares of stock for the time being.
  3. Expiration Date
    The further out date you buy the less volatile and risky the play is. You have more time for the stock to move the way you intend. Time decreses value on option contracts. Which is why contracts with further expiration dates are more expensive than ones expiring next week. I always recommend buying with at least 6 weeks till expiration. Most of the time I will buy 3 month out contracts, or longer.
  4. What Is Excercising an Option?
    It is not in your best interest to excercise unless you want to buy 100 shares of the stock. The community here likely does not have enough to purchase 100 shares so know this. Always sell the option back to the market before your expiration date. If the stock falls while you own the put, your contract is now worth more than what you bought it at. So take your profits and sell it to somebody else on the market.

If you dont understand options, dont worry. Buying shares of stock will serve all your needs. But if you want to take your investing to the next level, options are amazing. Leave a comment if you want us to go more in depth on options!!

Best Strategy For Hedging

If you have experience with options, than put options are for you. But I 10/10 recommend you buy the index ETF’s I listed above if you want to hedge your portfolio. They get the job done in the simplest way possible.

I say use about 5%-10% of your entire portfolio to buy your hedge. You NEVER want to overexpose your hedge. Holding it for a long time or a big portion will get you into trouble. Do not try and be a hero and save all your loses coming to your positions. If the market bounces back you will be kicking yourself.

Remember, the profits you make from your hedge are only meant to minimize loses. Don’t try and make up all the loses your stocks get, you will end up losing more!

Use Your Hedge Profits To Buy More Long-Term Positions

If you don’t see dips as buying opportunities than you will be a below average investor. Make sure to buy at the low prices, it’s the best thing you can do.

Dollar Cost Average into positions over the coming weeks/months. It’s the best way to get the best positions.

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