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Pls make it clear!!!

Ruchika Gupta (Chartered Accountant) (247 Points)

10 April 2008

What is HEDGE RATIO in the context of put and call options. I know how to calculate it but really can't understand the funda of hedging and hedge position! Please make it fundamentally clear!!!

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4 Replies

CA. Dashrath Maheshwari (TaXpert) (15090 Points)
Replied 10 April 2008

Hedge funds are complex, risky investment vehicles. Other funds, such as most equity mutual funds, have straightforward investment strategies. By contrast, equity-oriented hedge funds may engage in various trading practices and investment strategies. They may be short funds, long-short funds or market neutral funds. And equity-oriented hedge funds are only a small sliver of the hedge fund universe. Thus, assessing the risk of hedge funds is a challenge

CA Amarpal (Chartered Accountants) (149 Points)
Replied 12 April 2008

Hedge ratio is just to protect yourself from loss which may come on exercising on put or call option. Hege is used when rate for future can be forcasted, and two rates one is higher than exercise price and other one is lower than exercise price.

Krunal Raichura (Financial Advisory) (2134 Points)
Replied 14 April 2008

Investopedia says -

A ratio comparing the value of a position protected via a hedge with the size of the entire position itself.

A ratio comparing the value of futures contracts purchased or sold to the value of the cash commodity being hedged.

Say you are holding $10,000 in foreign equity, which exposes you to currency risk. If you hedge $5,000 worth of the equity with a currency position, your hedge ratio is 0.5 (50 / 100). This means that 50% of your equity position is sheltered from exchange rate risk.

According to me, the hedge ratio is the proportion of the hedge position to the total position. For example, if u have a portfolio of 40 crore rs, and u sell baskets of index futures to the tune of 10 crores only, then that means you have hedge only 25% of your total portfolio against the downside risk.