That answer is, “Yes you can”. Since traders are not permitted to short sell in the cash market for more than a day; one way is to sell futures. Suppose you sell Reliance Industries futures at Rs.980. You will make a profit if the price goes down. But what if the price goes up? You can hedge your short futures by buying a call option. Assume that you buy an Rs.990 Call option on RIL at Rs.10; then what is the protection that you get?

Short Futures

Amount

Call Option

Amount

Futures of RIL sold at

Rs.980

If price of RIL goes to

Rs.1050

If price goes up to

Rs.1,050

Profit on Call Option

Rs.60

Loss on short futures

Rs.70

Option Premium Paid

Rs.10

Hedge by buying

990 Call @ Rs.10

Net Profit on Call

Rs.50

Max Loss on position = Rs.(-20)

Max Profit – Unlimited on the downside

That is how options can be used to hedge (protect) your risk in a very simple way! You surely now agree that there is not much of rocket science to hedging with options!