1. What is Hedge Ratio?

The hedge ratio is a measure used to determine the optimal number of futures contracts needed to hedge a position in the spot market. It represents the relationship between the value of the position being hedged and the value of the futures contract.

2. How Does the Calculator Work?

The calculator uses the hedge ratio formula:

Where:

• \( \text{Correlation} \) — Correlation coefficient between spot and futures prices (range: -1 to 1)
• \( \text{SD Spot} \) — Standard deviation of spot prices
• \( \text{SD Futures} \) — Standard deviation of futures prices

Explanation: The hedge ratio accounts for both the correlation between the assets and their relative volatility.

3. Importance of Hedge Ratio

Details: An accurate hedge ratio is crucial for effective risk management in financial markets. It helps minimize basis risk and optimize hedging strategies.

4. Using the Calculator

Tips: Enter the correlation coefficient (between -1 and 1), standard deviation of spot prices, and standard deviation of futures prices. All values must be valid (SDs > 0, correlation between -1 and 1).

5. Frequently Asked Questions (FAQ)

Q1: What is a perfect hedge ratio?
A: A perfect hedge ratio of 1 means the futures position exactly offsets the spot position. This is rare in practice.

Q2: How often should hedge ratios be recalculated?
A: Hedge ratios should be recalculated periodically as market conditions change, typically weekly or monthly.

Q3: What if correlation is negative?
A: A negative correlation means the assets move in opposite directions, resulting in a negative hedge ratio.

Q4: What are limitations of this approach?
A: Assumes linear relationship and constant correlation/volatility, which may not hold in turbulent markets.

Q5: How is this used in portfolio management?
A: Helps determine optimal futures positions to reduce portfolio risk while maintaining desired exposure.