11.9What is hedging?
1What is it?
Hedging means taking a position that offsets the risk of another position, like insurance.
2Why does it exist?
Investors and businesses use it to protect against big adverse moves.
3Stock market example
You hold a portfolio worth ₹16 lakh that moves like the Nifty. Worried about a fall, you sell 1 Nifty future. If the market falls 5%, your portfolio loses ~₹80,000 but the short future gains ~₹81,250. Losses largely cancel.
4Diagram
Portfolio (−5%)
₹-80,000
Short future gain
₹81,250
Net
₹1,250
5Risks
- A hedge also cancels gains if the market rises.
- Hedges are rarely perfect (basis risk).
6Quick revision
- Offsets risk like insurance.
- Gives up upside too.
- Rarely perfect.
7Knowledge check
Q1. How can you hedge a stock portfolio?Show answer
Sell index futures or buy index puts.
Q2. Downside of hedging with futures?Show answer
Gains are also cancelled.
Q3. What is basis risk?Show answer
The hedge and the asset don’t move exactly together.