Finance Professor: Five Hedging Techniques You Must Know

5. Options

Options are the most complex tool available for hedging ("Options: Getting Started"). Options require an intimate knowledge of the non-linear aspects of options pricing in order to effectively execute hedge and manage risk.

Options require a much more detailed explanation before one can integrate their use into risk management. I will, however, state that you can consider one of three strategies:

• Selling covered calls: Selling a call against the position you desire to hedge.
• Buying puts: Buying put protection or insurance against your holding(s).
• Collaring: Simultaneously selling a covered call and buying a put to lock in a minimum and maximum potential sales price.

(To learn more about options, check out TheStreet.com Options Alerts.)

Your Homework

1. Identify a stock or stocks which could be sold short as a hedge against an individual holding

2. Calculate the risk of your portfolio and determine how many futures or ETFs are necessary to hedge the portfolio

3. Become more familiar with inverse and leveraged inverse ETFs

As always, you can email me your homework and thoughts on the subjects covered in this or previous articles. I will compile the best ideas in a future module of TheStreet.com University.