Definition of Hedge
Hedging is a strategy that allows the investor to reduce its investment risk and at the same time increase the size of the portfolio by taking the opposite position in the same asset. To understand the hedging let’s take the example of a Roulette table payouts. When you bet on the outside on 1st, 2nd, or 3rd 12 numbers you receive 2 to 1. If you divide your bet of $50 on the 2nd and 3rd row, and the roulette hits number 26 black, you will get $25 in addition to your bet of $50. You will lose $25 against the 3rd row and win $50 for successfully hitting the number in the 2nd row.
In investments when you take a short position on security hoping that the prices might fall. To hedge your short position you will have to take the long position by buying call options on the same security. If the prices increase you will enjoy the benefit by short selling your shares and not exercising the call options.
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