Definition of Hedge

What does the term "hedge" mean in the world of investing and trading? What is meant by a "hedge"?

A "hedge" is something that you spend money on in order to help mitigate any potential losses in an asset.

For instance - buying house insurance is a hedge, as you are spending money to protect against the possible loss of value in an important asset - your house.

Hedges exist in the world of trading and investing as well.

For instance - let's say that you own a large position of Microsoft common shares.

You don't want to sell your position, but you want to hedge against a possible loss, as you forecast stormy days ahead for the stock market.

In this case, you could buy puts in Microsoft, which would hedge against a drop in the price of Microsoft.

For instance - let's say that Microsoft's shares are trading at $200. You originally bought at $50 per share and don't want to sell.

You decide to buy $190 puts in Microsoft that expire in six months. In exchange for the premium that you pay, you gain the option of selling your shares in Microsoft at $190 per share.

This is a hedge.

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