How to Hedge Against Volatility

In this article, I will give you a few investment strategies you can use to hedge against risk when volatility increases. Let us look at some of the simple ways you can hedge your risks.

Invest in Bitcoin

As you invest in Bitcoin, you should remember that the cryptocurrency is highly volatile. This means that the price tends to make exceptionally large swings, which can lead to losses. You should not invest more than 10% of your funds into Bitcoin.

In a previous article, we looked at the top reasons you should invest in Bitcoin. In the article, we said that Bitcoin has been an exceptional hedge because it is uncorrelated to stocks. Therefore, if you are already invested in stocks, we recommend that you allocate some cash into Bitcoin.

You can do this in several ways. First, you can buy Bitcoins outright from an exchange. Some of the most popular Bitcoin exchanges are Coinbase, Kraken, and Binance. You can also use over-the-counter Bitcoin brokerage companies like OSL and Genesis Trading. Alternatively, you can buy Bitcoin futures that are offered by the CME Group. This is only possible if you are in the United States and is a bit complicated than buying Bitcoin outright. You can also buy Bitcoin CFDs, which mirror the current price. The benefit of doing this is that you can get leverage, which will help you make more money. Another option is crypto friendly banks such as Revolut, which allows you to buy and sell Bitcoin.

We don’t recommend using Coinbase to buy or invest in Bitcoin because of many issues such as transparency, privacy, and security. In addition, Coinbase is known for pushing and listing high-risk shitcoins.

Using Options to Hedge

The options market is one of the biggest in the USA. It is used mostly by experienced Wall Street professionals who want to benefit from the future price of an asset. An option is a contract that allows a buyer to sell the asset at a stated price within a specific time-frame and not the obligation to buy an asset. A call option usually gives you the right to purchase the asset while a put option gives you the right to force the buyer to sell the asset to you. There are several volatility-based strategy you can use to hedge against risk:

  • Straddle
  • Strangle
  • Long call butterfly spread
  • Calendar spread

Straddle Option Strategy

The first type of options is the straddle hedging strategy. Straddle is the purchase of options to buy and to sell a security or commodity at a fixed price for the purchaser to make a profit whether the price goes up or down. This type of option is made up of a call option and a put option with a similar expiry price. The options must expire at the same strike price. The goal of using this strategy is to benefit when the market is going through volatility. The challenge of using straddle options is that they tend to be relatively expensive than the others.

 

Strangle Options

Strangle hedging strategy is an option type that is similar to straddle but less costly. The option allows you to buy put and call options that expire at the same time. The difference is that the strike price for the option is usually different. Another difference is that at times, you will be out of money in some time especially when there is significant volatility.

 

Selling Volatility

Selling volatility option strategy is another hedging option. This is a strategy that requires some calculations and expertise. Ideally, you need to calculate and see whether options are being overvalued. If they are overvalued, a good option is to sell volatility by using a short straddle strategy. Another way is to short the several volatility indexes that are tradeable in the market. A good example of this is the CBOE volatility index.

 

Long Call Butterfly Spread

This is a relatively complicated trading strategy that involves combining a long call spread and a short call spread. The two converge at a strike price, which we can call B. The goal is to lose money with calls with strikes B and C and then make money when the in-the-money call strike A. The benefit of this strategy is that it is relatively cheap to execute.

Calendar Spread

What is calendar spread? This is an options strategy that allows you to buy and sell a call with the same strike price. The call you buy will expire later than the one you sell. As with the long call butterfly spread, this strategy is usually relatively cheap but difficult to execute.

 

Invest in Gold

Another strategy you can use is to invest in gold to hedge your risks. The reason for this is that gold tends to go up when stocks and dollar go down. Therefore, we recommend that you invest part of your cash in gold to take advantage of the low-interest rates and the weaker dollar.

Final Thoughts on How to Hedge Against Volatility

Hedging is a good way of protecting yourself in the period of sustained risks in the market. Using the approaches mentioned in this article will help you achieve better returns while protecting against potential downsides.

Ndesanjo is an experienced blogger and journalist. He was named one of 100 Influential Africans in Media Category. His mission is simple: making finance work for everyone. Read more about Ndesanjo and the whole editorial team at FiFi.