InvestorQ : I am a little unsure of the market. Should I protect my investments?
natasha Samani made post

I am a little unsure of the market. Should I protect my investments?

Answer
user profile image
Mitali Bhutta answered.
2 years ago


What do we understand by protecting the investments? The simple way is to put a stop loss, but that is for very short term investments. What do you do when the markets are extremely volatile? You can do hedging of your risk in the portfolio. The decision to protect the portfolio has to be taken carefully as it has two important implications. Hedging has a cost and that is a kind of sunk cost that reduces your portfolio ROI. If you are hedging through futures then there is a margin cost that you need to factor. If you are hedging through options then there is the cost of premium that you need to factor in. Secondly, hedging puts a cap on the returns on your portfolio being the price for reducing risk on the downside. For example, when you hedge with futures, your profits are tied to the spread between spot and futures prices. Also, when you hedge with put options it is fine because you are still profitable after the premium cost is covered. But if you try to reduce the premium cost by selling higher calls, then your upside profits are also limited. You need to factor this point also.