The Co-Founder and President of Highland Capital Management, James Dondero, has taken his company to great heights over the years. Highland Capital Management has done so well because it had a strong person at its leadership, especially during the troubled times. Because of his decades worth of experience, James Dondero has picked up some valuable leadership lessons and the most important among them is to always be prepared for the bad times. In the corporate world, especially in investment firms, this approach can be quite rewarding.
Hedging is something that all investment experts recommend. However, only few traders know about what hedging is and why it’s important. In the following points, James Dondero explains these points –
What Does Hedging Mean? – Hedging is exactly like insurance. People get life insurance so that their families and dependents would have protection in case something happens to them. Similarly, hedging is an activity undertaken to protect the trader against the market if something happens. It is there to limit the impact of bad events or downturns. When most beginner traders get interested in hedging, they wrongly assume that this activity would prevent the market from going against them. James Dondero explains that hedging would not impact the market in any way and good or bad turns would continue happening, except that the trader would now have security or insurance against negative events.
How Are Derivatives Related To Hedging? – Derivatives include futures and options and are financial instruments used by traders for the purpose of hedging. Using options and futures, traders devise a strategy that would protect them against the market’s swings. It works in a unique way where the trader gets the derivative that is usually the opposite event of the underlying financial instrument. This means that if the market goes down, the derivative kicks in and the trader still ends up making a profit (or limiting losses to zero).
James Dondero explains that options, in particular, are quite popular and have helped many traders avoid losses in companies whose shares have gone down. For instance, if a trader thinks that the short term prospects of a share seem troubled, they could buy put options. The options gives the trader a “right” to sell or buy shares at a particular price and kick into effect when the price reaches a certain level. This means that using the put option, the trader would be able to sell the share at a particular price and make profits on the put. The losses due to the share would, thus, be offset against the profits.
Does Hedging Cost Money? – Like any other insurance, hedging too costs money to the trader. But that price is a lot less than what the trader would have to pay if they don’t hedge their securities. The cost of the derivative, for instance, is a fixed cost that the trader would have to pay, even if the derivative is not on the money.
James Dondero has used various hedging tools to protect himself against the market over the years. He advises traders to research about hedging for long term benefits.