DEFINITION of 'Downside Protection'

The use of an option or other hedging instrument in order to limit or reduce losses in the case of a decline in the value of the underlying security. Downside protection often involves the purchase of an option to hedge a long position. Other methods of downside protection include using stop losses or purchasing assets that are negatively correlated to the asset you are trying to hedge.

BREAKING DOWN 'Downside Protection'

An example of downside protection would be the purchase of a put option for a particular stock. If an investor already owns shares and the price of that stock falls, the value of the option will increase and thus limit the total loss exposure.

RELATED TERMS
  1. Cross Hedge

    The act of hedging ones position by taking an offsetting position ...
  2. Inflation Hedge

    An investment that is considered to provide protection against ...
  3. Hedge

    Making an investment to reduce the risk of adverse price movements ...
  4. Forex Hedge

    A transaction implemented by a forex trader to protect an existing ...
  5. Hedge Accounting

    A method of accounting where entries for the ownership of a security ...
  6. Protective Put

    A risk-management strategy that investors can use to guard against ...
Related Articles
  1. Managing Wealth

    Practical And Affordable Hedging Strategies

    Learn how to find and use the most cost-effective ways to transfer risk.
  2. Investing

    For Maximum Market Returns, Get Creative With Hedges

    Proper hedges help to contain your losses while still allowing profits to grow.
  3. Trading

    A Beginner's Guide To Hedging

    Learn how investors use strategies to reduce the impact of negative events on investments.
  4. Investing

    Creating Highly Effective Hedges With Index LEAPS

    Index LEAPS can be a highly effective way to hedge a retirement portfolio consisting of index or mutual funds, without the effort of short-term options trading.
  5. Trading

    Hedging Basics: What Is A Hedge?

    This strategy is widely misunderstood, but it's not as complicated as you may think.
  6. Investing

    Hedging for Beginners: A Guide

    People hedge as insurance against market volatility. Anyone can do it; here's a primer.
  7. Investing

    Insure Your ETF Investments With Options

    Learn how to insure and hedge against unfavorable moves in ETF investments using options strategies, such as the protective put and the protective collar.
  8. Investing

    Hedging With Puts And Calls

    This trading strategy can reduce your risk - but only if you use it effectively.
  9. Investing

    A Beginner's Guide To Hedging

    Hedging is a practice every investor should know about.
  10. Trading

    A Guide Of Option Trading Strategies For Beginners

    Options offer alternative strategies for investors to profit from trading underlying securities, provided the beginner understands the pros and cons.
RELATED FAQS
  1. What is a cross hedge?

    Cross hedging is when you hedge a position by investing in two positively correlated securities or securities that have similar ... Read Answer >>
  2. What are the most effective hedging strategies to reduce market risk?

    Learn about different hedging strategies to reduce portfolio volatility and risk, including diversification, index options ... Read Answer >>
  3. What happens if you don't hedge your investments?

    Learn the purpose, advantages and disadvantages of hedging, and find out how to utilize hedging to enhance an overall investment ... Read Answer >>
  4. If I use hedging as a risk strategy, do I have to keep my eye on my portfolio all ...

    Understand the concept of hedging and learn how this key element to portfolio management can help an investor protect profits ... Read Answer >>
  5. Is it possible to be perfectly hedged against risk?

    Learn what it means to mitigate the market risk of a portfolio through hedging and to what extent hedging can reduce downside ... Read Answer >>
  6. How do hedge funds use short selling?

    Learn how hedge funds use short selling to profit from stocks that are falling in price. Explore different analytical techniques ... Read Answer >>
Hot Definitions
  1. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  2. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  3. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  4. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  5. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  6. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
Trading Center