Daryl Guppy provides three profit-capturing strategies.

Classic hedging is a do-nothing strategy that gives the appearance of your taking action when in fact you are doing little. The classic hedge is designed as an offset – you lose money on one position and make up the loss with the gain in another, related, position. It’s a neutral strategy.

Often the purpose of hedging strategies is to keep a portfolio return matching a benchmark, such as the performance of an index. Neutral strategies use the power of leverage offered by derivative instruments to compensate for losses in less-leveraged stocks and in open positions.

I prefer aggressive hedging. I want to make a profit from my hedge, not treat it as an insurance policy where I surrender the premium irrespective of any claim. That is how options are used in a hedging environment.

I apply hedging strategies only because I am unable, or unwilling, to sell the underlying position. This may be due to investment constraints, superannuation regulations, inability to go short with the stock, or because it is a genuinely long-term investment. My objective is to use a small amount of cash to deliver substantial returns, which are then injected as new capital into investment positions as the market recovers. Such strategies are used to protect portfolios or investment positions.

There are three types of aggressive hedging:
1. hedging an individual stock;
2. hedging a portfolio;
3. hedging a market...

Excerpted from an article originally published in the Sep/Oct 2011 issue of YourTradingEdge magazine. All rights reserved. © Copyright 2011, Your Media Edge Pty Ltd.
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