What is Hedging | GK Pelliron

Hedging - opening trades in one market to compensate for the impact of price risks equal but opposite position in another market. Usually hedging is carried out with the purpose of security price changes risk by entering into transactions on the futures markets.

The most common type of hedge - hedging futures contracts. The origin of futures contracts was due to the need of insurance against commodity price changes. The first operations were carried out with futures in Chicago on commodity exchanges is to protect against sudden changes in market conditions. Until the second half of the XX century hedging (the term was already fixed in some regulatory documents) used exclusively for the removal of price risks. However, it should be noted that the aim of hedging is not the removal of the risks and their optimization.

Hedging mechanism lies in balancing the obligations in the cash market (goods, securities, currencies) and opposite in direction in the futures market.

In addition to the transactions with futures, hedging operations can be considered as transactions with other derivative instruments: forward contracts and options. Hedging result is not only the reduction of risks but also the reduction of possible profit. There are hedge buying and selling. Hedging purchase (buyer hedge, long hedge) due to the acquisition of futures that the buyer provides insurance against possible future price increases. When hedging sales (seller hedge, short hedge) there is supposed to make a sale on the market of real goods, and for the purposes of insurance against a possible price reduction is carried out sale of derivative instruments in the future.

The purpose of hedging (risk insurance) is protection from adverse price changes in the stock market, commodity assets, currencies, interest rates, and so on.

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