Options Hedging Strategies: All You Need to Know
- 12th February 2026
- 04:15 PM
- 9 min read
An options hedging strategy is a structured approach to efficiently use the option contract to protect it against any potential risks in the market. You can think of these strategies as insurance for your investments. They add a cushion that might help lower losses in case the market moves against your expectations.
As per the SEBI, there are 13.6 crore investors investing directly in the stock market. Being one of them, if you are interested in option hedging as well, employing effective strategies might enhance your profit potential.
This blog covers the definition of such a strategy and how it works with popular hedging strategies that you can employ.
What is an Options Hedging Strategy and its Working?
Before diving deeper into exploring different options hedging strategies, you must first understand what option hedging is. Options allow you as an investor to hedge against any persisting risks of stocks or any other assets that you hold in your portfolio.
With an option, you obtain the right but not the obligation to purchase and sell a certain asset, for example, a company’s stock at a predetermined price at a future date. Suppose the prices of a stock move unfavourably and fall sharply. Here, traders can exercise their options. The gains from them help offset the losses that traders might incur in regular trades.
However, if the prices do not fall, traders can choose not to exercise their options and make a benefit from their regular trades. However, in the latter case, traders lose only the premium paid to hold the option.
Thus, this ability to manage risks of your holdings along with managing other risks makes options a potentially efficient hedging tool to maintain your overall portfolio.
Definitions of the Call and Put Options
To understand option hedging strategies with more clarity, you must first have an idea of call and put options related to this strategy. Here is a detailed breakdown
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Explanation of Call Options
When you buy a call option, it allows you the right but not an obligation to buy an asset at a predetermined price or a strike price within a set period. When traders buy a call option, they purchase it expecting that the asset prices can rise in the future.
Thus, if the market price of that asset rises beyond your set strike price, you may exercise a call option and buy those assets at a lower cost. Suppose you buy a call option at INR 2100 for a stock trading at INR 2000, expecting it to rise. Now, if the price rises to INR 2200, you make a profit of INR 100 per share.
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Put Options Explained
A put option in an options hedging strategy allows you to sell an asset at a preset price at a set date. When you buy a put option, the anticipation here is that the asset price is likely to fall. Thus, the aim here is to exercise the put option at a higher strike price, limiting losses from a decline.
Suppose you hold a company’s stock, i.e. currently trading at INR 2000. You anticipate a price drop and buy put options at INR 1900. Now, say its price drops to INR 1800. You can now exercise your put option and still keep some profit even if there is a decline.
What are Some Popular Option Hedging Strategies?
Now that you have noted details about call and put options, you must note how you might exercise options via different strategies and hedge against fluctuations. Here are 4 strategies that are popular in option hedging:
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Protective Put Strategy
As a part of an options hedging strategy, a protective put potentially allows you to protect your long stock position in your portfolio. To put it more simply, when you have company stocks in your portfolio and anticipate a price drop, you can buy protective puts for them. It allows you to potentially sell those shares at a higher strike price even if prices drop.
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Covered Call Strategy
Traders consider this a selling option hedging strategy. With it, you can sell your call options on stocks that you already own. This way, you can generate an additional income from the premium of the option. It may cover potential losses from drops in stock prices
Suppose you sell a call option on some shares you own, trading at INR 1000 at a strike price of INR 1030. Thus, you can earn from the premium, but if stock prices rise beyond INR 1030, then you might still need to sell them at the same strike price.
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Collar Strategy
This strategy is essentially a combination of both the protective put and covered call. It means, with this strategy, you buy put options protecting against downside risks. By selling a call option, you cover or offset the price of that put option.
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Spread Hedge
It is one options hedging strategy where you identify related assets that historically respond to market changes in a similar way. Suppose you identify two different assets from a single sector and take opposite long and short positions in those assets. Now, any increase in one of those positions can offset the potential losses in the other.
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Steps to Start Hedging with Options
After noting the option hedging strategy and its variations, you must learn the practical steps on how to start with it. Here is a detailed breakdown:
Step 1: Choose a trusted stockbroker like the PL, and create a Demat and a trading account.
Step 2: Carefully assess the options market and choose contracts that are potentially efficient for hedging, while considering underlying assets, expiry date, etc. Based on your investment horizon, risk appetite, etc, choose daily, weekly or monthly contracts.
Step 3: To reduce risk, carefully decide on your strike price, keeping in mind the volatility and the position size.
Step 4: Open the position you have chosen to execute your options hedging strategy.
Step 5: Monitor the market and performance of the options contracts. Make required adjustments to your strategy to increase profitability potential and lower losses.
How Does Hedging Protect Investors?
While you note steps to start options hedging, you must also note some of its key benefits for which you might want to use this strategy:
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Downside Protection and Risk Mitigation
If you apply options hedging strategies accordingly, it might protect you in case an asset’s market moves against your expectations. Especially, it helps lower downside risk when the market is highly volatile. You can use it for risk mitigation as it optimises your portfolio performance by offsetting losses from one investment with gains from the other.
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Customised Protection
Using strategies of option hedging for your owned stocks, you can adjust them to align with your risk tolerance, financial goals, etc. Thus, it provides personalised protection to your portfolio.
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Profit-Making Opportunities in Different Conditions
Option hedging might also allow you to ensure potential profits if your chosen asset’s market moves up or down.
Key Tips for Effective Option Hedging
When you decide to start with option hedging and implied strategies, you must keep in mind some tips. These might help implement effective strategies and achieve potential benefits:
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Choose the Right Strategy
Clarify your objective to use option hedging and choose a strategy accordingly. For example, to protect your stocks from a potential loss, you may opt for a protective put. To generate an additional income, you might opt for a covered call to earn from the premiums.
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Note the Premium Costs
Option hedging comes with an additional cost of a premium. At their expiry, you sacrifice the premiums paid. Therefore, you must weigh the premium cost against the amount of losses you are protecting your portfolio from. If the premiums outweigh the covered losses, then using option hedging might not be beneficial.
Conclusion
An options hedging strategy allows you to safeguard your investment portfolio against potential losses or to buy assets at a lower target price when their prices go up. However, before employing such strategies, you must get a clear idea of the options market, involved risks, etc, to minimise losses.
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Frequently Asked Questions (FAQs)
1. What is an option hedging strategy?
It helps to protect your portfolio from unexpected market swings while still keeping the room for growth open. It acts as an insurance for your investments.
2. How can I hedge my portfolio using options?
You can implement an options hedging strategy based on your financial objective and risk appetite, and choose from protective put, covered call, or collar strategies, among others.
3. What is the safest option for a hedging strategy?
You might find a covered call as a potentially safer strategy in option hedging. With it, you can sell a call option to earn from premiums while protecting your existing stocks from downside risks.
4. Is option hedging suitable for beginners?
Understanding the concept of the options market might seem difficult for beginners. Therefore, if you are new, it is advisable to learn the options market first, practice its strategies using a demo account before using them in live trading.
5. What are the most effective options hedging strategies in India?
The common and potentially effective strategies for option hedging in India are protective put, covered call, collar, spread hedge, etc.
