Hedging

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This is an investment strategy. When you hedge, you try to limit the chances of losing a lot of money because of something bad that might happen. It's typically done when you have made a risky investment; if it goes very well you stand to gain a lot of money, but if it performs badly, you could lose a great deal of money. If you are worried about your investment performing poorly, you can try to hedge. In the stock market you can do this by using put options and call options. If you have bought a lot of shares in one company and are worried that the price might fall, you can buy a put option that allows you to sell some (or all) of the shares at a price that is low but still better than if the price drops a lot. It costs money to buy a put option, but it gives you some protection in case the worst happens. Even though the stock may plummet you have the ability to sell at the put option price. For example, you buy a stock at $50. You think it could go up to $100, but it's a volatile company and there is a risk that bad things could happen just as easily as good. You buy put options at $50, which are valid for a limited time. If the stock goes up, you can make a profit - less the amount you paid for the put option. But if the stock drops to, say, $10, it is not a disaster because you can then exercise the put option and sell your stock at $50. Because you sold for the same price you bought, all you have lost is the price you paid for the put option. Hedging happens everywhere in the world of finance: when people want to protect themselves against a possible disastrous investment, they can hedge. See also Hedge Fund.