Today we will learn the concept of Hedging.

Suppose you have a house worth 1 crore and you have spent your entire life savings to build it. If something happens to this house — it may put your financial goals in trouble.

In such a case what will you do?

The answer is to insure your house against damages, natural calamities, and accidents. Insurance will ensure the financial value of the house is protected. The act of insuring something such that in the event of losses, the financial losses can be recouped by claim settlement is called Hedging.

You might end up paying some premium every month or every year for that insurance — but as long as that financial asset has value, the insurance will protect it against bad events.

Similarly — every financial asset can be hedged. Be it gold, fixed deposits, stocks, or mutual funds.

Assume you have an MF or stocks portfolio of value X (X could be any number — 1lakh or 10lakh or whatever up to your risk profile)

You can engineer a hedge to prevent that value of X from eroding. That is done by derivative instruments like options or futures.

The advantage is that even if the market falls — your value of X will remain as it is (for downside protection)