What Is Hedging? A Real S&P 500 Hedge, Tested Year by Year

Michael Whitman · Trading since 2017, full-time since 2020 · YouTube creator, 137K subscribers · Published 2026-09-06 · Updated 2026-11-02 · Reviewed 2026-11-01

Hedging is opening a second position that should make money when your main position loses it, so a bad move costs less. It works like insurance: you give up some of the upside, or pay a fee, to shrink the downside. A hedge never deletes risk. It trades a large, familiar risk for a smaller and stranger one.

Plenty of pages stop at the farmer-and-futures story. This one runs a real hedge on real prices: a $10,000 stake in the S&P 500 protected with an inverse fund, checked every calendar year from 2007 to 2025, so you can see what the protection saved, what it cost, and where it quietly stopped working.

How it works

Every hedge has two legs. The first is the exposure you already hold: shares, a crop, a foreign currency payment due in three months. The second is a position chosen because it tends to move the other way.

The tools vary by market. A wheat farmer sells futures to lock in a price before harvest. A shareholder buys a put option, which pays if the share falls below a set price.

An investor in an index fund can hold an inverse ETF, a fund built to return the opposite of the index each day.

The second leg cancels gains as readily as losses. If the market rises, the hedge loses, and that loss is the price of having had protection. On top of it come the bid-ask spread and fees on a second position.

Some hedges trade upside for income. Writing a covered call against shares you own brings in a premium that cushions a small fall, while capping the gain if the price jumps.

Opposite trades in the same instrument do not count. Being long and short the same share in one account is a closed position paying two sets of costs. A real hedge offsets an exposure that cannot, or should not, simply be sold.

A worked example: SPY hedged with SH

The setup. Hold $10,000 of SPY, an S&P 500 index fund.

To hedge half of it, buy $5,000 of SH, ProShares Short S&P500, which aims to return the opposite of the S&P 500 each day. Net market exposure starts at $5,000.

The comparison is the plain alternative: sell half and hold $5,000 of SPY plus $5,000 in cash. Returns below include dividends; the cash is counted at 0%, and neither version is rebalanced during the year.

In the falling years the hedge did its job. In 2008 the SH leg gained $1,940.67 and cut the year’s loss by about half. In 2022 it gained $948.81, and the hedged pair ended $868.73 down instead of $1,817.54.

In 2011 the hedge turned a small gain into a loss. SPY ended the year up 1.89%, but it got there through a steep summer drop and a recovery, and SH lost 7.82% over the same months. The pair lost $201.70 in a year when simply holding SPY made $189.50.

2020 was the expensive one. The March crash and the fast rebound left SPY up 18.33% and SH down 25.09%. The hedge leg lost $1,254.26, and the hedged pair made $337.68 less than the halved version.

2023 went the other way. A steady climb left SH down only 14.80% while SPY rose 26.18%, so the hedged pair beat the halved one by $568.76. The same hedge, on the same index, behaved differently every year, and the next section shows why.

Two choices in this setup favor the hedge. The hedged version ties up $15,000 against $10,000, and the halved version’s cash is counted at 0%. Counted instead at what a 1-3 month Treasury bill fund (BIL) returned, that $5,000 would have earned $79.29 in 2008, $70.23 in 2022 and $247.24 in 2023.

On that basis the hedged pair was ahead of halving by $21.64 in 2008, behind by $30.19 in 2022 and ahead by $321.52 in 2023. Across the 18 years from 2008 to 2025 it came out ahead in 9.

Why the legs drift apart

SH resets every day. It aims for the opposite of one day’s move, not of a year’s move, and daily returns compound. Day to day it tracked closely: on 83.8% of sessions from June 2006 to October 2026, SH’s return was within 0.10 percentage points of the exact opposite of SPY’s.

Over a year, that small daily gap and compounding add up. If SH were a perfect mirror, SPY’s yearly return plus SH’s would be zero. Across the 19 calendar years from 2007 to 2025, the sum ranged from -6.75 points (2020) to +11.38 points (2023), and it was below zero in 7 of the 19 years.

The years in the table above scored +2.02 (2008), -5.93 (2011), -6.75 (2020), +0.80 (2022) and +11.38 (2023).

Trending years helped the hedger, choppy years hurt. In a steady trend, compounding works in the inverse fund’s favor; in a market that swings both ways and goes nowhere, it works against it. That pattern matches the years above, but it describes the past and gives no read on the next year.

This gap has a name: basis risk. Whenever the hedge is not the exact same instrument as the exposure, the difference between them is risk you still carry.

It shows up with an index hedging a single share, one futures month hedging another, or a daily-reset fund hedging a buy-and-hold stake. How closely two legs move together is a correlation question, and correlation changes.

Sizing the second leg

Size by money at risk, not by share count. Convert both sides to dollars and multiply by how strongly the exposure moves with the hedging instrument. For a single stock hedged with an index, that sensitivity is its beta.

Options are sized through delta. A put does not move dollar for dollar with the share; it moves by its delta, so the number of contracts follows from the delta, not the holding.

And the size drifts. As prices move, the two legs change value at different rates, so a hedge set once stops matching what it was meant to offset.

The original data

The full test uses SPY and SH daily adjusted closes from 21 Jun 2006, SH’s first session in the Yahoo data, to 30 Oct 2026: 5,123 shared sessions. Calendar-year returns run from the last close of the prior year to the last close of the year.

Left alone, the hedge disappeared. Over the whole period SPY returned +775.2% with dividends and SH returned -90.9%. A $5,000 SH position bought on day one and never resized was worth $455.43 by 30 Oct 2026, against a SPY holding that had grown more than eightfold.

Long before the end, the “hedged” portfolio was simply a long position with a small, shrinking short attached.

That is a sizing failure, not a broken fund. SH did roughly what it says each day. The hedge failed because nobody resized it, which is the most common way a long-running hedge goes wrong.

When it fails

Basis. The exposure moves and the hedge does not follow it closely enough, as in 2011 and 2020 above.

Range-bound markets. A trading range brings neither the fall the hedge was bought for nor a clean trend, and a daily-reset hedge loses value while it waits.

Buying protection after the fall. Option protection is priced off expected movement, so implied volatility makes it most expensive just when hedging feels most obviously right.

Treating it as a stop. A stop loss closes the exposure; a hedge keeps it and adds a second one, so risk per trade still has to be set first.

Costs on the short side. A hedge built through short selling pays borrow fees and can be recalled, and a thinly traded hedge with little volume is costly to lift when you want out.

Gaps. An opening gap can move the two legs by different amounts before anyone can adjust.

Forgetting it. A hedge is a decision about a period. Left on for years, it either fades away, as SH did, or keeps canceling gains long after the risk has passed.

Questions people ask

What is hedging in simple terms?

Taking a second position that should gain when your main position loses, so a bad move hurts less. You give up some upside, or pay a fee, in exchange.

What is an example of a hedge?

Holding $10,000 of an S&P 500 fund and $5,000 of an inverse S&P 500 fund. In 2022 that pair lost $868.73, against $1,817.54 for the fund alone.

Does hedging remove risk?

No. It reduces the main risk and adds basis risk, the gap between the two legs. In 2011 the pair above lost money while the index alone made money.

Is hedging the same as diversification?

No. Diversification spreads money across holdings that do not move together. A hedge adds a position chosen to move against one that you already hold.

Related

Risk management sets position size before any hedge is added, and a smaller position is often the simpler fix. Correlation measures how closely the two legs move, which decides how much basis risk remains. And options are the instrument most bought protection is built from, each with a price attached.

This page is educational, not financial advice. Test every idea on your own charts before risking money.