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- Hedging - pros and cons
- Financial risk hedging types
- Financial risk hedging methods

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Financial risk hedging methods

Let's take a closer look at each method of hedging financial risks:

  • Pure hedging.

    It involves the parallel opening of opposite positions in the market of the necessary asset and in the market of urgent instruments. So, simultaneously with the opening of a transaction for the purchase of securities, it is worth buying an option for their sale in constant volume at a similar price. Due to the net method, the trader or investor manages to achieve complete preservation of the capital if there is a decrease in quotes.

  • Full and partial hedging.

    A trader or investor may spend less on insurance if they decide to hedge only a fraction of the transaction volume. Then the investor pays less for futures or an option. A partial approach is considered the best option in cases where the chances of reducing the value of assets are minimal. If the situation is reverse and the risks are high, you do not need to try to save - it is more profitable to hedge in full.

    For example, an investor sells 200 thousand euros for dollars, expecting a depreciation of the European currency against the dollar. Since the probability of such a development seems to him quite high, he chooses to partially hedge financial risks and acquires a call option for half the amount of the transaction (100 thousand euros). With an option value of 2%, savings will be equal to 2000 euros, but financial risks will increase significantly, because only half of the transaction amount has insurance coverage.

  • The anticipating hedging.

    This method assumes that transactions in the market of fixed-term contracts are concluded earlier than transactions in the market of real assets. At the same time, they work with futures, which are analogues of typical supply contracts. Note that they can be used together with delivery and settlement (non-delivery) futures.

    Let's imagine that the investor wants to purchase shares in the future, but they can rise in price. At the moment, the trader cannot afford this purchase, so the investor enters into a futures contract for a future purchase at a fixed price, using a anticipatory approach.

  • Selective protection.

    In this case, in the market of fixed-term instruments and in the market of the underlying asset, transactions are concluded that vary in time and volume.

    For example, an investor in may acquires 200 shares of the company, which he plans to sell in early autumn, and in july opens an option for 300 shares (the term for the exercise of this option is december). Such a decision may be caused by his personal interests.

    It should be understood that only experienced exchange speculators can work with the method of selective insurance against financial risks.

  • Cross-hedging.

    Here, the base asset differs from the fixed-term contract asset. So, the trader sells oil and at the same time concludes an option to buy gold for personal preferences and considerations. This method is also suitable only for professional players in the market.