# Hedging > Hedging means taking a position that offsets the risk of another. Learn how hedges work with options, futures and correlated assets, their costs and limits. Source: https://learn.tradelabsai.com/markets/hedging/ Track: Markets and Instruments · Level: Beginner · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "Hedging", https://learn.tradelabsai.com/markets/hedging/ Hedging is reducing risk by taking a position that tends to gain when another position loses. It works like insurance: you accept a cost or give up some potential profit in exchange for protection against a bad outcome. A hedge is not meant to make money on its own. Its job is to make the combined result less painful when things go wrong. ## Hedging vs speculation | | Hedger | Speculator | |---|---|---| | Goal | Reduce an existing risk | Profit from a price move | | Starting point | Already exposed, such as owning shares or growing a crop | No exposure until the trade | | Success looks like | Smaller losses, steadier results | Profit on the position | Both need each other. Hedgers transfer risk; speculators accept it in return for a potential reward and supply the liquidity hedgers need. ## Common ways to hedge ### Buying put options If you own shares, buying a [Protective Put](https://learn.tradelabsai.com/options/protective-put/) gives you the right to sell at the strike price, capping your downside for the cost of the premium. **Example: Insuring a stock position** You own 100 shares at $150, worth $15,000. You buy one three month put with a $140 strike for $3.50, or $350. If the stock falls to $110, your shares lose $4,000 but the put is worth $30 × 100 = $3,000, so your net loss is about $1,350 including the premium. If the stock rises instead, the put expires worthless and the $350 is the cost of the insurance. ### Selling futures A portfolio manager holding $1 million of large US stocks can sell S&P 500 index futures to offset market risk without selling the stocks. A farmer can sell crop futures to lock in a price. See [What Is a Future?](https://learn.tradelabsai.com/markets/what-is-a-future/). ### Collars Buying a put and selling a call on the same shares can make protection cheap or free, in exchange for capping the upside. See [Collars](https://learn.tradelabsai.com/options/collars/). ### Offsetting correlated positions Pairs of assets that usually move together can hedge each other. A trader long one bank stock might short another, or short a bank sector ETF, to remove the risk of the whole sector falling while keeping a view on the individual company. See [Pairs Trading](https://learn.tradelabsai.com/strategies/pairs-trading/). ### Currency hedging An investor buying foreign stocks is exposed to the foreign currency. Forward contracts or currency futures can remove that risk so returns reflect only the stocks. See [FX Forwards and Forward Points](https://learn.tradelabsai.com/forex/fx-forwards-and-forward-points/). ## The hedge ratio A hedge rarely needs to cover 100% of a position, and assets do not always move one for one. The **hedge ratio** is the size of the hedge relative to the exposure. For a stock portfolio hedged with index futures, traders often use beta: a portfolio with a beta of 1.2 needs about 1.2 times its value in index futures to offset typical market moves. See [Alpha and Beta](https://learn.tradelabsai.com/portfolio/alpha-and-beta/). ## The costs and limits of hedging - **Direct costs:** option premiums, commissions and spreads. - **Opportunity cost:** many hedges reduce gains when the market goes your way. - **Basis risk:** the hedge may not move exactly opposite to your position. A tech heavy portfolio hedged with a broad index can still lose if tech underperforms. - **Over hedging:** a hedge larger than the exposure becomes a speculative bet in the other direction. - **Timing:** hedges expire or need rolling, and protection bought after a fall is more expensive. **Tip: Hedge what you cannot afford, not everything** Hedging every position all the time usually costs more than it saves. Many traders hedge only specific risks, such as an earnings report, a large concentrated holding or an uncertain macro event, and otherwise control risk through position sizing. ## Frequently asked questions ### Does hedging eliminate risk? No. It reduces or reshapes specific risks, usually at a cost. Some risk always remains, including the chance the hedge does not work as expected. ### Is hedging only for big investors? No. Individuals can hedge with protective puts, inverse ETFs or by reducing position sizes, although costs and minimum sizes matter more for small accounts. ### What is a perfect hedge? A position that moves exactly opposite to the original exposure, removing all of its risk. In practice, perfect hedges are rare because instruments rarely match exactly. ## Sources - Wikipedia, [Hedge (finance)](https://en.wikipedia.org/wiki/Hedge_%28finance%29) ## Continue learning - Next lesson: [Arbitrage](https://learn.tradelabsai.com/markets/arbitrage/) - Previous lesson: [Margin](https://learn.tradelabsai.com/markets/margin/) - Related: [Margin](https://learn.tradelabsai.com/markets/margin/): Margin is the deposit you put up to borrow money or open leveraged positions. Learn initial and maintenance margin, margin calls, interest and how to avoid them. - Related: [Protective Put](https://learn.tradelabsai.com/options/protective-put/): A protective put buys a put on shares you own to limit downside. Learn the payoff, what protection costs, how to choose strikes and when hedging makes sense. - Related: [What Is a Future?](https://learn.tradelabsai.com/markets/what-is-a-future/): A futures contract is an agreement to buy or sell something at a set price on a future date. Learn how futures work, margin, leverage, settlement and who uses them. - Related: [Correlation Management](https://learn.tradelabsai.com/portfolio/correlation-management/): Correlation management keeps a portfolio from turning into one big bet. Learn to measure correlations, combine correlated risks and set sensible limits. - Related: [Delta Hedging](https://learn.tradelabsai.com/options/delta-hedging/): Delta hedging offsets an option position's directional risk with the underlying. Learn how it works, how often to rehedge and what risk remains. - Related: [Collars](https://learn.tradelabsai.com/options/collars/): A collar holds shares, buys a protective put and sells a call to fund it. Learn the payoff, zero cost collars, strike choices and who uses this hedge. - Related: [What Is a Derivative?](https://learn.tradelabsai.com/markets/what-is-a-derivative/): A derivative is a contract whose value comes from another asset. Learn the main types, futures, options, swaps and forwards, why they exist and their risks.