Short answer: Options hedging is the practice of protecting an existing holding by taking an opposite position, often by buying an option contract. The most basic version is the protective put, which limits how far a share holding can lose value if its price falls, in exchange for a premium paid upfront.
Last reviewed: 14 November 2026
At a glance
| Term | What it means |
|---|---|
| Hedging | Protecting one position by taking an opposite position, which reduces losses from adverse price moves |
| Option contract | Gives the holder the right, but not the obligation, to buy or sell an asset at a strike price on or before a date |
| Protective put | Buying a put option on a holding to insure against a fall in its price |
| Futures contract | Fixes a buy or sell price for a future date, creating an obligation to transact |
| Premium | The price paid for an option, a real cost to the buyer |
| Time decay | The loss of an option’s value as its expiry date approaches |
What does it mean to hedge a stock position?
Hedging means protecting one position by taking another position that moves in the opposite direction. If you hold shares, the hedge is designed to cushion the loss if their price drops. The hedge does not remove risk entirely; it changes how much of the risk you carry.
A hedge works like insurance. You pay something to reduce a loss you would otherwise bear fully. Like insurance, the cost is paid whether or not the bad event happens.
How does an option contract work?
An option contract gives its holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price, called the strike price. The right can be used on or before a specified date, which is the expiry. A call option is the right to buy, and a put option is the right to sell.
Because the buyer can walk away, the option’s price, called the premium, is paid to the seller at the start. The buyer’s maximum cost is that premium. The seller takes on the obligation to honour the contract if the buyer chooses to use it.
How does a protective put work?
A protective put involves buying a put option on shares you already own. The put lets you sell those shares at the strike price, even if the market price has fallen well below it. If the market rises instead, the put expires unused, and you keep the gain on your shares minus the premium you paid.
The catch is that the premium is spent whether or not the market falls. In a rising market, the premium is a drag on your returns, and in a flat market it is simply lost.
Worked example: how the numbers play out
The figures below are hypothetical and invented for illustration only.
Suppose you hold 100 shares bought at ₹1,000 each, a total of ₹1,00,000. You buy one put at a strike price of ₹950, paying a premium of ₹20 per share, or ₹2,000 in total.
- If the price falls to ₹800: Without the put, each share loses ₹200, so the loss is ₹20,000. With the put, you can sell at ₹950, so the loss per share is ₹50 plus the ₹20 premium, or ₹70. The total loss is ₹7,000.
- If the price rises to ₹1,100: Each share gains ₹100, or ₹10,000 in total. The put is not used, and the premium of ₹2,000 is subtracted, leaving a net gain of ₹8,000.
The put caps the loss in the falling case, but it reduces the gain in the rising case. This trade-off is the core of how a protective put works.
How do futures compare with options for hedging?
Futures contracts also hedge by fixing a buy or sell price for a future date. The key difference is that a futures contract creates an obligation to transact, while an option gives a right. A futures hedge locks in the price, so it protects against falls but also gives up gains if prices rise.
An option hedge keeps the upside, because you are not obliged to use the option. The price of that flexibility is the premium. Which structure fits a given situation depends on the specific terms of each contract, and this article does not assess that for any individual.
What are the costs and catches?
Option premiums and other hedging fees are a real cost. Repeated hedging, paying premiums again and again, can erode long-term returns even if individual hedges are sensible on their own terms. In the worked example, a ₹2,000 premium is a 2 per cent cost on the ₹1,00,000 holding before any price movement.
Time is another catch. An option’s value decays as its expiry approaches, so a put bought today loses some value each day, even if the share price does not move. A hedge that expires without being used has done its job as insurance, but the premium is still gone.
Frequently asked questions
Is a protective put free?
No. The premium is a real cost paid to the seller of the option, and it is paid whether or not the share price falls.
Does an option hedge have to be exercised?
No. An option gives its holder the right, but not the obligation, to buy or sell, so the holder can let it expire unused.
Why does an option lose value over time?
Option value decays as expiry approaches, so the option can lose value even if the underlying price does not change.
What is the main difference between a futures hedge and an option hedge?
A futures contract creates an obligation to transact at the agreed price, while an option gives a right without an obligation.
Sources and last check
Facts in this article were checked against the sources below on 14 November 2026. Rules and figures can change; check the primary source before acting.
- upstox.com (broker education)
- kotakneo.com (broker education)
- groww.in (broker education)
- 5paisa.com (broker education)
This article is general information, not investment advice. MyFinanceBandhu is not a SEBI-registered investment adviser.