There are many great ways to use options to hedge positions. Some can include diversifying risk to other asset classes, while others are just a straight "insurance" play. In any case, most investors know of some of the different options they have to hedge. We have written many articles on hedging portfolio's, and individual positions from either a spike in prices or a sharp decline. Today we will take it a step further and discuss hedging a position that is not necessarily correlated to the S&P 500, rather a global stock position.

In today's example we will use the example of a long position on a Brazilian oil company Petroleo Brasileiro (PBR  ). With the recent volatility in oil prices it would be normal to assume that you may have an oil position or two in your portfolio, but what if its not an american company? In this case we have the Brazilian oil producer which naturally has exposure to to the price of oil, but also has exposure to Brazilian political events as well.

In a normal oil position one could use oil itself to hedge if you felt that was needed. There are many popular ETF's for oil but the United States Oil Fund (USO  ) would be the direct way to use an ETF for that hedge. In our case though we have a Brazilian company and we would want to look to hedge using a Brazilian ETF if possible.

The iShares Brazil ETF (EWZ  ) is our best, most liquid ETF to use for such a vehicle. This ETF is comprised of 59 Brazilian companies and some of them are in the oil space. If we were long shares of PBR in our example we could utilize short call spreads or naked calls to sell against our shares. This would generate a credit for us while we wait but our hedge would be limited. If we were to purchase puts on the EWZ this would give us a continued hedge against our PBR. The question is how much hedge should we put on?

The first thing we want to know is how correlated PBR is to EWZ. Currently the EWZ will move $0.90 for every $1 PBR moves so its almost a perfect correlation. In other words they move almost perfectly together. Lets assume we want to buy puts on EWZ to hedge some of our PBR. Remember that each strike price has a "delta" and depending on the strike you select, you can choose your delta. If we had 100 shares of PBR and we bought one at the money put we would be hedging just under 50% of our position (if it were a perfect 1 for 1 correlation then it would be exactly 50%). Now, one would never try to hedge their whole PBR position. If you were that worried about a decline then you would just exit your position all together.

With this hedge we are now protecting against some decline in oil but also any Brazilian political risk as well. While this is a more complicated example of how to hedge, hopefully it shows you the many opportunities you have when wanting to take some risk off while keeping a position.