Double Hedging

What Is Double Hedging?

Double hedging is a trading strategy wherein an investor hedges a cash market position utilizing both a futures position and a options position. This is utilized when it isn't effective or is unimaginable due to regulatory restrictions to utilize just one derivatives market to complete a hedge.

Grasping Hedging

Double hedging uses both a futures contract and an options contract to increase the size of a hedge in a market position. Like any hedging strategy, a double hedge is planned to safeguard investors from losses due to price variances. Utilizing a double hedging strategy, investors are able to reduce their risk by purchasing put options as well as short positions in the futures market of a similar amount as the underlying long position.

The hedge is doubled when there is lacking liquidity in both of the options or futures markets all alone, or on the other hand in the event that executing a full hedge in just one market would trigger a position limit.

As defined by the Commodity Futures Trading Commission (CFTC), a double hedge would be required when a trader holds a position in which a futures market hedge would surpass the speculative position limit and offsets a fixed price sale albeit the trader has adequate supply of the asset to meet sales commitments. As per the CFTC, a speculative position limit is the maximum position in a given commodity future or option that an individual entity might hold, except if that entity is eligible for a hedge exemption.

For example, an investor with a stock portfolio of $1 million who wishes to reduce risk in the broad market can start by purchasing put options of a comparable amount on the S&P 500. By in this way starting an extra short position in the S&P 500 utilizing index futures contracts, the investor double hedges, decreasing risk and improving the probability of a bigger overall return.

Other Hedging Investment Strategies

Investors will generally think of hedges as insurance policies against loss. For example, an investor who might want to invest in and partake in the benefits of an effective emerging technology, however who requirements to limit the risk of loss in case the technology doesn't deliver on its commitment, may shift focus over to a hedging strategy to confine the possible downside.

Hedging strategies depend on the utilization of derivatives markets to work, especially options and futures. Futures contracts are commitments to trade an asset at a set price at a predetermined time from here on out.

Options contracts, then again, happen when the buyer and seller consent to a strike price for an asset at the very latest a set expiration date, however there is no obligation for the buyer to purchase the asset as a matter of fact. There are two types of options contracts, put and call.

Put option contracts give the owner of an asset the right, yet not the obligation, to sell a specific quantity of an asset at a set price by a set date. On the other hand, a call option gives the speculative buyer of an asset the right, yet not the obligation, to purchase a specific quantity of an asset at a set price by a set date.

Features

• For example, a long investor might sell futures and furthermore purchase put options to kill any downside moves in the market.
• A double hedge would be looked for in the event that one of the futures or options markets had deficient capacity to handle the total size of a required hedge, either due to regulatory limits or illiquidity.
• A double hedge happens when a trader utilizes the two futures and options to hedge an existing position.