Protective puts, spreads and index hedges — when a hedge is worth its cost and when it just reduces returns.
Key takeaways
- A hedge converts open-ended risk into a known, paid-for cost.
- Spreads reduce margin requirements as well as risk.
- Hedging a position you should simply exit is an expensive way to avoid a decision.
The cleanest hedge is a defined-risk structure entered at the start. Selling a call spread instead of a naked call caps the worst case and reduces margin, at the cost of some premium. For most retail traders this trade is strictly better than the naked version.
For a delivery portfolio, index puts or a short index futures position can offset broad market risk while you keep stock-specific exposure. The cost is the hedge premium and the drag if the market rises — which is precisely the insurance being purchased.
Hedges also help around events. Reducing net delta into a policy decision or a results date keeps you in the position without betting the account on a binary outcome.
The misuse is hedging as avoidance. Adding a short leg to a losing position to 'stop the bleeding' typically locks in the loss while adding complexity and cost. If the thesis is broken, exit; hedging is for risk you have chosen to keep.
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