Hedging
Hedging is a risk-management strategy that takes an offsetting position to reduce the impact of an adverse price move on an existing investment.
A hedge works like insurance. You accept a cost, or give up some upside, to limit potential losses. The goal is not to make money on the hedge but to reduce how much a portfolio can lose.
Common hedges include buying put options on stocks you own, selling stock index futures against a portfolio, holding bonds or cash alongside stocks, and using currency forwards to offset exchange-rate risk on foreign investments. Companies hedge too, for example when an airline buys fuel futures.
Example: an investor owns 100 shares of a stock at $80 and buys a put with a $75 strike for $2. If the stock falls to $60, the put gains $15 per share, limiting the loss to about $7 per share including the premium, instead of $20.
Hedges are rarely perfect. Costs reduce returns in good times, and the hedge may not move exactly opposite to the asset, which is called basis risk. Over-hedging can also remove most of the upside.