September 22, 2023

A how-to guide on hedging with ETFs

Exchange-traded funds (ETFs) have quickly become one of the most preferred investment vehicles for traders and investors in the Netherlands due to their potential to generate income with minimal risk. However, ETFs also come with risks that should be managed to ensure a successful trading experience. Hedging is essential for mitigating these risks while allowing investors to access the potential gains through ETFs.

Hedging is a risk management strategy that helps protect traders and investors from downside losses by offsetting market fluctuations. While hedging may reduce returns, it also reduces risks if done correctly. This guide introduces hedging with ETFs in the Netherlands and explains critical steps for doing so effectively.

Understand the basics of hedging with ETFs

Hedging with ETFs is a popular strategy in the Netherlands, allowing investors to limit their losses while capitalising on potential gains. Hedging is about managing risks and limiting exposure to market swings; investors will open two positions simultaneously: long and short. The long position will expose the market’s upside, while the short position will protect against downside losses. Hedging is usually done using derivatives; traders and investors commonly use futures contracts, options, swaps, and other hedging instruments to offset risks associated with ETFs.

When deciding how much to hedge with ETFs in the Netherlands, it’s essential to consider the investment goals and risk tolerance. Hedging should only be done when there is a real need to reduce risks, as it will reduce potential returns. As such, investors should ensure that their hedging strategy reflects their overall investment goals.

Choose the suitable ETFs for your hedging strategy

Once the basics of hedging with ETFs are understood, it’s time to decide which ETFs to choose. A wide range of ETFs is available in the Netherlands, and selecting the right ones for your hedging strategy is essential. When choosing an ETF for your hedging strategy, you should consider its liquidity, fees and expense ratio, investment objectives, and asset allocation. You can see which ETFs are available in the Netherlands on the Saxo website.

ETFs are liquid, meaning there are enough buyers to sustain their prices in the market. These will make it easier to implement hedging strategies effectively. Fees and expense ratios should also be considered when selecting an ETF for hedging purposes; these costs can add up quickly if you trade frequently or over a long period. Ensuring that the ETFs you choose match your investment goals and risk tolerance is vital. Consider the asset allocation of the fund when trading ETFs; this can help reduce risks and enable a more diversified portfolio.

Decide on a hedging strategy

Once suitable ETFs are selected, it’s time to decide which hedging strategy to use. Different strategies can be used for different goals; however, some of the most popular ones are purchase and hold, delta-neutral hedging and yield enhancement.

Purchase and hold is a simple strategy that involves buying an ETF with a long position and holding it until its value has increased significantly. Delta-neutral hedging involves trading options on the ETFs to offset potential losses. Lastly, yield enhancement is an advanced strategy using long and short positions to increase returns.

It’s essential to thoroughly research your preferred strategies; some may require more experience or knowledge than others, so check the associated risks before committing any capital. Once familiar with the strategies, you can start implementing them by opening a brokerage account and purchasing the ETFs.

Monitor your hedging positions

Once the hedging strategy is implemented, monitoring the performance of both long and short positions is essential. Monitoring involves tracking price movements, fundamental factors such as earnings and dividends, and other market conditions. By regularly monitoring the performance of your positions, you’ll be able to adjust your strategy, if necessary, to meet your investment goals.

It’s also essential to monitor fees associated with hedging; these can add up quickly and affect overall returns. You should also check for hidden costs, such as taxes, commissions and spreads. By regularly monitoring the performance of your ETF hedging strategy, you’ll be able to make intelligent decisions and minimise losses.

Adjust positions

As market conditions change, it is essential to adjust your position accordingly. If the long position increases in value while the short position decreases, consider reducing the long position to minimise potential losses. On the other hand, if the short position increases in value while the long position decreases, you may want to increase your long position to maintain an optimal level of risk. It is also essential to diversify positions across different ETFs and markets; this will help reduce volatility and ensure a more robust portfolio.