De-hedge

When looking over the Star Wars saga, one has to admire the cynicism of Obi Wan Kenobi. He saw how powerful Anakin Skywalker had become, and that he would eventually become Darth Vader. He knew that the Emperor was playing ruthlessly while the Jedi were still trying to maintain a code of honor. He hedged his bets by placing Padma’s twins, both of whom would likely inherit Skywalker’s gift of the Force, on separate worlds: Leia with Senator Organa on Alderaan, while Luke goes to his uncle and aunt on Tatooine. Obi Wan thus hedged the worst case scenario of the Jedi being wiped out by preserving Luke, who would be Episode IV’s, A New Hope. Once he saw that Luke had learned what he needed in order to go the next step with Yoda, he lifted the hedge and joined the Force.

When one De-hedges a trading position, it is much the same, mechanically. A hedge is put into place as a contingency in case the trader’s gut was wrong and limits a loss to a fixed amount. Derivatives like options are often used in these cases, where the cost of the derivative is factored into the profit or loss.

Other hedges can involve going long on two different companies or sectors whose stocks would benefit in opposition to each other, which could be over pending legislation, a lawsuit or other policies. If the trader was correct and the trade is on its way to becoming profitable, the trade may be de-hedged to allow the profits to run further. The de-hedging can be a close out of the derivative position, a sell off of the opposite long position, or other manifestations.