What is the main purpose of establishing equity options hedges?

• A. To increase the portfolio's equity exposure
• B. To reduce the equity risk of a portfolio
• C. To enhance speculative profits
• D. To invest in risk-free assets

Answer: (B)

The primary purpose of establishing equity options hedges is to reduce the equity risk of a portfolio. Hedging with equity options allows investors to protect their portfolios against adverse price movements in the underlying stocks, thereby mitigating potential losses. This risk management strategy is crucial, especially in volatile markets where equity values can fluctuate significantly.

By using options, investors can create positions that offset potential losses in their equity holdings. For example, purchasing put options provides the right to sell the underlying asset at a predetermined price, allowing the investor to effectively limit potential losses on their portfolio. This form of insurance is a fundamental aspect of risk management for institutional and individual investors alike.

In contrast, increasing a portfolio's equity exposure or investing in risk-free assets does not align with the primary intent of hedging; these strategies are focused on growth or securing capital, rather than managing existing risk. Similarly, while options can be utilized to enhance speculative profits, this is not the main goal when establishing hedging strategies. The central theme in hedging is protecting against downside risk rather than seeking higher returns.