In finance, a hedge is an investment that is undertaken specifically to remove (or reduce) the risk in another existing investment.

Perfect hedge

A perfect hedge is a position taken up by an investor that would completely eliminate the risk of another existing position. Such a position would require 100% negative correlation to the investment to be hedged and is rarely found. Most hedges are imperfect or near-perfect at best.

Equity Hedging

A stock investor can hedge individual long stock positions by buying protective put options, provided there are options traded for that stock.

Entire portfolios can also be hedged against systemic market risk by using index options. See index collar.

Futures Hedging

A futures trader can hedge a futures position against a synthetic futures position. A long futures position can be hedged with a synthetic short futures position. Similarly, a short futures position can be hedged against a synthetic long futures position.

Hedging Commodity Price Risk

Businesses that produce or consume raw materials can remove commodity price risk by hedging in the commodity futures market. Long hedges are utilized to lock in the future purchase price of a commodity. Short hedges are used to lock in a selling price for a commodity to be sold in the future.

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