Hedge ratio
The relationship between the number of contracts required for a direct hedge and the number of contracts required to hedge in a specific situation. The concept of hedging is to match the size of a positive cash flow from a gaining futures position with the expected negative cash flow created by unfavorable cash market price movements. If the expected cash flow from a $1 million face-value T-Bill futures contract is one-half as large as the expected cash market loss on a $1 million face-value instrument being hedged (for whatever reason), then two futures contracts are needed to hedge each $1 million of face value. The hedge ratio is 2:1. Hedge ratios are used frequently when hedging with futures options, interest rate futures, and stock index futures, to aid in matching expected cash flows. Generally, the hedge ratio between the number of futures options required and the number of futures contracts is 1: 1. For interest rate and stock index futures, the ratios may vary depending on the correlation between price movement of the assets being hedged and the futures contracts or options used to hedge them. Most agricultural hedge ratios are 1: 1.
Hedger
One who hedges; one who attempts to transfer the risk of price change by taking an opposite and equal position in the futures or futures option market from that position held in the cash market.
Hedging
Transferring the risk of loss due to adverse price movement through the purchase or sale of contracts in the futures markets. The position in the futures market is a substitute for the future purchase or sale of the physical commodity in the cash market. If the commodity will be bought, the futures contract is purchased (long hedge); if the commodity will be sold, the futures contract is sold (short hedge).
High
The top price paid for a commodity or its option in a given time period, usually a day or the life of a contract.
