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How to Hedge Your Portfolio Using Options

Submitted by admin on June 9th, 2026

A portfolio hedging strategy is a risk management technique aimed at minimizing the risk of potential losses given an adverse market situation. Rather than selling investments in times of uncertainty, investors can also choose to use options contracts to cap their losses while still holding on to potential profits.

Although a hedge does not completely remove risk, it may help to mitigate losses during downturns in the market.

Understanding Put Options

The most frequently used hedging instrument is a “put option. A put option is one of the most widely used hedging instruments. A put option is an option contract that provides the buyer with the right, but not the obligation, to terminate a contract and receive the fixed price (called the strike price) for a purchased asset prior to the expiration date of the option.

When the market drops, the put option will typically gain in value, which will offset the losses in the underlying portfolio.

Example

Now, imagine that a trader has a stock portfolio with ₹5 lakhs invested in various stocks. The investor buys a put option on Nifty 50 as he is apprehensive about the possibility of a short-term fluctuation in the markets.

• In case of a strong downtrend:
• There is a risk of the value of the portfolio falling.
• The put option gains value.
• The advantage of the option helps to diminish the overall loss.
• This tactic is known as a protective put.

Protective Put Strategy

One of the easiest and best hedging strategies is the protective put.

Benefits

• Limits downside risk.
• Allows investors to retain ownership of stocks.
• Offers comfort in times of uncertainty.

Drawbacks

• The value of the option premium is a cost.
• The premium paid may be worthless if the market goes up.
• A premium should be considered as an insurance cost, not a certain profit opportunity for investors.
• It is possible to hedge with options.

A large number of investors have diversified portfolios that closely mimic the overall market. Hedging can be done by purchasing put options on the index of stocks, like purchasing Nifty or Bank Nifty options as opposed to purchasing individual stock put options.

Advantages

• Lower transaction complexity.
• Broader market protection.
• Effective in diversified portfolios.

One of the reasons why many institutional investors and professional portfolio managers use index options is because they provide exposure to the market as opposed to just a single stock.

Collar Strategy

A more popular hedging approach is the collar strategy.

In a collar:

The investor purchases a put option that serves as a protection.

2. The investor simultaneously sells a call option.

The premium takes the place of the premium needed to be paid to buy the put.

Benefits

• Lower hedging cost.
• Defined risk range.

Limitation

• The upside gain can be capped in case of a large rally in the market.
• This strategy is often used by investors who prioritize capital preservation over maximizing returns.

Important Considerations

• When evaluating the option for hedging, investors need to take those into account:
• Size of portfolio and amount of market exposure.
• Premiums on options and transaction fees.
• Expiry dates.
• Strike price selection.
• Risk tolerance and investment goals.
• The hedge should be custom made and not a blanket approach.

Conclusion

Options may be useful when it comes time to safeguard investment portfolios in times of uncertainty. Protective put, index-option hedging and collars are some of the strategies used to control downside risk while not having to sell shares outright.