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Gap risk is the risk that the price of an investment security may change significantly without any market trading taking place, causing a detrimental effect on a portfolio. Investors can manage this risk by hedging against a price drop or selling the stock. Gap risk commonly occurs with company stocks due to after-hours news announcements or unforeseen negative events. Investors must decide how to manage gap risk, such as selling stocks with gap potential or hedging with options to sell a breached stock.
Gap risk refers to the risk that the price of a particular investment security may change significantly without any market trading taking place. If an investor owns that security, the fall in value can be detrimental to a portfolio. You need to worry about gap risk, which commonly occurs with company stocks, if some after-hours news announcement causes a change in how investors view the stock in question. To manage this risk, investors should consider hedging against a price drop or even selling the stock to avoid the potential drop.
When stock prices change during a trading day, investors may be aware of movements up or down in the shares they own. That way, if the price of a particular stock starts to drop rapidly, they can usually get rid of it before any major damage is done. However, there are certain times when the price of a stock can change without being affected by a single trade. These overnight price swings can be detrimental, so investors need to be aware of the concept of gap risk and how to manage it.
This phenomenon is known as gap risk because of the gap that is created when a stock’s price falls from its closing price overnight to its opening price the next morning. The difference between the two prices is the gap. It can be a benefit to investors if the price of the shares they own rises overnight, increasing the value of those shares. Conversely, a sudden price drop is a serious problem for investors holding on to a stock.
There are several reasons why such breaches occur and make investors concerned about the potential risk of breaches. It is common for earnings reports for companies offering shares to be released after business hours. If earnings reports are not emblematic of the price at which the stock is trading, a gap is likely. Also, an unforeseen and negative event that happens to a company during non-business hours can lead to a stock plunge overnight.
With all the possible causes of a looming gap, investors must decide how they want to manage gap risk. The easiest way to avoid this is to sell the stocks that contain gap potential. For example, if an investor learns that earnings reports from the company that issues him shares are due overnight, he may simply sell the shares before trading closes to avoid the consequences of a disappointing report. . Hedging, which can be achieved by buying options to sell a breached stock, can also mitigate the damage of a price decline.
Smart Asset.
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