In investment terms, what is a hedge?

In investment terms, what is a hedge?

• A. A speculative bet to double capital.
• B. An investment strategy designed to manage risk, often involving buying put options.
• C. A guarantee of profits.
• D. A strategy to avoid all risk.

Answer: (B)

Hedging is about protecting a position by reducing potential losses, rather than chasing large gains. It’s a risk-management approach that aims to offset adverse market moves. A common way this is done is by buying put options on an asset you own; the put gives you the right to sell at a set price, so if the asset’s price falls, your losses are cushioned by the option’s value or by selling at the higher strike price. Of course, the hedge costs money (the option premium) and won’t eliminate all risk or guarantee profits, and it may cap upside if the asset soars. Hedging can also use other tools, like futures or diversification across uncorrelated assets, but the core idea remains: reduce risk exposure rather than promise profits or avoid risk entirely. That makes the description “an investment strategy designed to manage risk, often involving buying put options” the best fit.

Hedging is about protecting a position by reducing potential losses, rather than chasing large gains. It’s a risk-management approach that aims to offset adverse market moves. A common way this is done is by buying put options on an asset you own; the put gives you the right to sell at a set price, so if the asset’s price falls, your losses are cushioned by the option’s value or by selling at the higher strike price. Of course, the hedge costs money (the option premium) and won’t eliminate all risk or guarantee profits, and it may cap upside if the asset soars.

Hedging can also use other tools, like futures or diversification across uncorrelated assets, but the core idea remains: reduce risk exposure rather than promise profits or avoid risk entirely. That makes the description “an investment strategy designed to manage risk, often involving buying put options” the best fit.