HEDGING

Hedging is the purchase of one asset with the intention to reduce the risk of loss from another asset.

IMPORTANCE TERMS IN HEDGING

LONG HEDGE – Long hedging is the transaction in which we hedge our position in the cash market by going long in the futures market. for example, we expect to receive some funds in the future and want to invest the same amount in the securities market. we have not yet decided on the specific company/companies, where investment is to be made. we expect the market to go up shortly and bear the risk of acquiring the securities at a higher price.
SHORT HEDGE – A short hedge is a transaction when the hedge is accomplished by going short in the futures market. for instance, assume we have a portfolio and want to liquidate shortly but we expect the prices to go down shortly This may go against our plan and may result in a reduction in the portfolio value. to protect our portfolio’s value, today, we can short index futures of an equivalent amount. the amount of loss made in the cash market will be partly or fully compensated by the profits on our future position.

CROSS HEDGE – When a futures contract on an asset is not available, market participants look forward to an asset that is closely associated with their underlying and trade in the futures market of that closely associated asset, for hedging purposes. they may trade in futures in this asset to protect the value of their asset in the cash market. this is called cross hedge.
HEDGE CONTRACT MONTH – Hedge contract month is the maturity month of the contract through which we hedge our position. for instance, if we use July 200 X contract to hedge our portfolio’s market risk, our hedge contract month would be July 200 X contract. Similarly, if we hedge say risk on crude oil price with the help of September 200 Y, hedge contract month would be September 200 Y . -BY A GOWRISH R BHAT