how do hedge funds work? Do they buy "puts" and "calls" or do they buy shares and short the same stock?

Answer 1

In theory, a hedge fund engages in arbitrage, buying one security and selling a different, but very similar one and making money on the difference with minimal risk, but in the present arrangements, hedge funds can engage in any sort of speculation and can buy or sell any security or derivative or asset it likes to. It's the wild west in the financial arena.

Answer 2

Hedge funds use a variety of practices. Some of them seem very little like real hedging.

In conversation, if someone said "There is this...and there is that...and on the other hand there are these others"--you would say they were hedging on their answer. Hedging in investing is sort of like that.

The famous Jack Bogle invented index mutual funds for the purpose of 'hedging' your bets by buying the whole segment of something you are intested in. Another, not quite so famous, investor had his fund's money in a top auto parts retailer, Autozone, and found a dual opportunity when looking for alternate (hedge) opportunities--so he bought a lot of KMart when it emerged from bankruptcy, and then added Sears, the merged firm called Sears Holdings. Still another hedge manager uses stock futures and option spreads, the esoteric stuff commonly called derivatives.

Some of your 'puts and calls' are things that you can do with some investments, all by yourself. You buy a stock that has options traded. You buy a put to protect the value should the stock fall. You buy a call to protect value should the stock rise. Then when a trend is obvious, you abandon the losing position. Of course, some folks don't bother with the underlying stock, just going for the pure profit play of the options themselves and of the direction they are expecting. In some cases you might do a spread, winning from a relative change of value over time. A seasonal company, for instance, will be going up (or down) at one part of the year and the opposite later on. Others look for prices that correspond to dividends, for instance if a stock takes a dip simply because it has gone ex-dividend, well, if you subscribe to "buy low, sell high", then this is low and when it starts to rise before the next dividend cut-off date--that is high.

Others see the swings of price with increasing interest in the company, or lack of it. For instance, a falling price starts slowing, trading volume starts dropping, short interest starts getting smaller--buy. Price is going up, but volume spikes and short interest swells, so join the short interest and sell the stock short also, so you just sold high and will buy it back when it is lower--if you are right. Here is where the options come in again, you buy one for the other direction, to hedge your value if you are wrong.

Answer 3

hedge funds got their name by the abilities they have to hedge but in today's markets hedge funds are not really hedge funds. they are extrememly aggressive funds since they have the ability to use strategies to seek returns that normal mutual funds can't such as short selling. Most hedge funds require a minimum net worth such as 1,000,000 and a minimum investment amount such as 100,000 since to remain a hedge fund they can not have over a certain amount of investors therefore to have a decent amount of money in the portfolio they need wealthy investors