Question

Hedge Ratio: If changes in the spot price are perfectly positively correlated with changes in the futures price, does that mean the hedge ratio is always equal to 1?

Answer 1

Yes, the statement stands right that the spot price and future price are perfectly positively correlated when the hedging ratio is 1.

It states the value of the position to be protected through the use of hedging strategy in the position.

It is considered as a strategy for mitigating the risk and offsetting the trading loss that could occur in a large number. Further, it is used by all types of investors either large or small to protect their investment from the risk of downsizing and reducing the impact of cash losses in the trade.

We had to select a certain portfolio percentage that an investor wants to hedge to minimize the impact of risk on it.

The options are also hedged if they are the portfolio parts but it comprises the cost of premium payment. The hedge portfolio is determined by the indices of the market that would closely match the portfolio.

For example, there is a portfolio of the value of $10 million. The index of the S&P 500 had chosen to be the most appropriate on average calculated on average basis of the portfolio stand at 1. This would mean that if an investor wants to hedge a full portfolio then it needs $10 million.

Investors had to determine that the worth it would consider being forfeited on an upside basis. The selling of the call option would be able to minimize the cost of hedging and simultaneously limits the gain. Also, future contracts sold would limit the return.