I’ve hard of “hedging” when someone wants to “lock in” a position’s profit, without selling the stock. I was told this is for tax reasons because if you hold the stock over a year you get taxed lower.
But doesn’t that require additional capital? Do I use options?
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This is easier to explain with sports betting I feel.
NZ and the UK are playing a rugby game. You make a bet with your mate 1:1 odds NZ wins – you gets $10 if NZ wins and they get $10 if the UK wins.
Then NZ beats SA in another game, and the UK loses to Australia. Suddenly, NZ winning looks much more likely.
You want to “lock in” your wins, so you talk to your other friend. They’re willing to make a bet 3:1 NZ wins – so you pay them $5 if NZ wins but they pay you $15 if the UK wins.
You’re now neutral on the outcome. Combining the two bets – If NZ wins you make $10 – $5 = $5, if the UK wins you make $15 – $10 = $5. You’ve “locked in” the profit or are “fully hedged”.
You can do the same to “lock in” a loss. Say that instead, NZ loses a few games. You think that it’s likely to get worse so, you bet your mate $5 to you if NZ loses, $15 to them if they win.
Now, combined with your first bet, you loose $5 no matter what happens, which is better than loosing $10 but ofc worse than just winning the original bet. Again you’re “hedged”.
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