Why hedge, why not just buy a smaller position?

s0mmi said:
When you are trading a product Outright, you are playing a high-variance game.

When you are trading a product via Spread, you are playing a lower-variance game.
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I think you are conflating a spread position with a hedged position. The key difference is that a hedge is executed with an express purpose of reducing variance on the trade without changing the expected value. Hedge in itself has no alpha and, in fact, should be viewed as a cost. It's not uncommon to use a single hedge position for a bunch of alpha assets.

It could be very difficult to say which leg of the spread is the alpha leg. The purpose of a spread position to take a view on a relative dislocation of two or more assets.

PS. To make things more confusing, the above logic relates mostly to delta-one products. Options spreads can and should be mentally decomposed into an alpha leg plus a hedge leg.
 
Most who understand how to Hedge will not post about how it is done period. Most won't say how or why or how well it is done. I been hedging Commodities since 90s and cause of my style of very long term commodities, have to hedge as I am seeking the extremes on charts to go against immediate trend. I started like most Retail does, didn't like to lose at some point and using options to hedge made sense, like any faucet of any business you find tricks as months/decades goes by, and when you discover something, never discuss it. I hedge anything that won't be a day trade whether stocks/commodities.

There are still few areas of trading much of retail never considers cause of steep learning/knowledge that it entails like Spread trading and much about using options. Trading is about keeping an open mind and very long hours testing ideas.

Large traders and firms will use the futures to hedge their dividend stocks, they might have bought stocks in 2009 and all paying dividends, so when you get over extended market, they long millions of stocks of certain value, and go short large or Emini S&Ps futures of equal/less/more of value in hopes that correction ends and they will lift their futures position or even reverse the futures and make more on profit of futures, whereas the hedge was so as not to loss value on the stocks but retain dividends. They might do a double Hedge of going short the futures and do Call options in case they were wrong in timing, all kinds of different ways to hedge and different times of putting them on. They can sell the futures and sell OTM call options, many approaches depending on their backtested models.

Most get it wrong on hedging, it lowers risk, smaller drawdowns and done right, well.......you just going to have to work on for your answers.
 
Hedgeing is not compulsory, not necessary.

When you invest in stocks, you should have decided where is your cut loss level.
eg if stock goes down and you lost 10% of whatever you put in, cut loss immediately.

When you do spreads, you should have in mind where is your cut loss level.

similary if you day trade, you might decide to set stop at say 15 ticks.


It doesn't mean if you don't hedge, you would be loosing lots of money.


If you invest in stocks,
and you want to buy put option for that stock, by all means go and do it.
But if the stock drop by huge percent, you have to decide whether to
continue holding to that stock, or close the position.
 
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ironchef said:
Market makers almost always hedge? Professional traders often hedge and harvest small returns, but with OPM they can achieve consistent, high probability of profits.

As a retail mom and pop trader, I found hedging costly. There is no free lunch for me. Hedging reduce risks but also reduce returns.

Any words of wisdom is greatly appreciated.
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Any play you make needs to turn out to have been correct for you to benefit... including offsetting hedges. That is... if you buy puts to hedge and the market/issue does not decline, the hedge "didn't work out" and cost you. All you got was some temporary peace of mind for the cost of the premium.

Holding a large cash position is also a hedge. But if the market goes up without you, your cash hedge "didn't work out" and hurt your results.

Exercising your stop is also a hedge.

IOW... hedges help your portfolio only when they work out. All the rest of the time they hurt you.... same as owning/shorting issues.

To make any real money in the markets you usually need to make a large, unhedged bet and be correct.
 
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IronFist said:
Except in cases where someone doesn't know the direction the market is going to go and is trading each side separately, I don't know how hedging provides an advantage.
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I too wonder about this. I'm more confused when someone tells me they're trading "small position size" and still hedging.

I just assumed they're sticking to their trading plan regardless to the size of the trade.
 
Hedge is a crux for poor direction awareness, it ties up money and reduces your profit, up side it reduces your loss, so if you a poor trader, you'll merely lose less via hedging, if profitable you'll make less, so hedging less important.

It's likely the notion of if you stay in the game long enough you'll get lucky eventually, this keeps them in the game, but at a cost of never having a shot.
 
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