Hedging versus Betting

In a recent article published on Seeking Alpha, I posted this screen cap, showing the optimal put to hedge the biotech stock Amylin Pharmaceuticals against a greater-than-29% drop over the next seven months:

A commenter analogized the put to a lottery ticket and wrote about how unlikely it would be for an investor to “make money” on it. That misses the point of hedging, of course. The point of a hedge isn’t to “make money” on it, but to limit your losses in the event an investment goes against you. In the best-case scenario, your hedge will expire worthless because the underlying security you are hedging has appreciated significantly.

Another commenter on the article wrote,

I would never hedge on a company I believe in anyway. Kind of like putting a $6.00 show ticket on “I’ll have another”.

To which I responded,

Hedging isn’t betting. It’s insuring against intolerable losses. If I were betting against a stock I didn’t own, in most cases, I wouldn’t buy the same puts I would buy if I owned the stock and wanted to hedge it. For a more detailed explanation of that difference, see the paragraph titled “Hedging versus Betting” in this article: http://seekingalpha.co…

By the way, I’ll Have Another was just scratched from the Belmont: http://n.pr/NmKCZM

Even horses (and stocks) you believe in can fall to perform.

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