Optimal Hedge Ratio Calculator
Calculate the optimal proportion of hedging instruments to minimize portfolio risk
Calculate Optimal Hedge Ratio
Volatility measure of the underlying asset's spot price (typically 0.01 to 0.50)
Volatility measure of the futures contract price (must be greater than 0)
Correlation between spot and futures price changes (between -1 and 1)
Hedge Ratio Results
Formula: Optimal Hedge Ratio = ρ × (σₛ / σf)
Effectiveness: Moderately Effective Hedge
Interpretation: Moderate hedge: Hedge 50-80% of the position for balanced risk management.
Risk Management Analysis
Detailed Risk Analysis
Example Calculation
Portfolio Alpha Example
Spot Price Standard Deviation: 0.05 (5%)
Futures Price Standard Deviation: 0.072 (7.2%)
Correlation Coefficient: 0.83
Risk Profile: Moderate volatility with strong correlation
Calculation Steps
1. Optimal Hedge Ratio = ρ × (σₛ / σf)
2. Optimal Hedge Ratio = 0.83 × (0.05 / 0.072)
3. Optimal Hedge Ratio = 0.83 × 0.6944
4. Optimal Hedge Ratio = 0.5764
5. Hedge Effectiveness = 0.83² = 68.89%
Hedge Effectiveness Guide
R² ≥ 80%: Highly Effective
Strong hedge with excellent risk reduction
R² 50-80%: Moderate
Good hedge with reasonable protection
R² 25-50%: Weak
Limited effectiveness, consider alternatives
R² < 25%: Ineffective
Poor hedge, minimal risk reduction
Key Concepts
Hedge Ratio: Proportion of portfolio to hedge
Standard Deviation: Measure of price volatility
Correlation: Relationship between spot and futures
Effectiveness: Percentage of risk eliminated
Understanding Optimal Hedge Ratio
What is Optimal Hedge Ratio?
The optimal hedge ratio is the proportion of a portfolio that should be hedged using financial derivatives to minimize risk. It represents the most effective balance between risk reduction and the cost of hedging.
Formula
h* = ρ × (σₛ / σf)
Where:
• h* = Optimal hedge ratio
• ρ = Correlation coefficient
• σₛ = Standard deviation of spot price
• σf = Standard deviation of futures price
Applications
Important Considerations
Correlation Stability
Historical correlation may not predict future correlation. Monitor and adjust hedges regularly.
Transaction Costs
Include brokerage fees, bid-ask spreads, and margin requirements in hedging decisions.
Basis Risk
Imperfect correlation between spot and futures creates residual risk that cannot be hedged.
💡 Pro Tips
- • Use rolling correlations to capture changing market relationships
- • Consider dynamic hedging strategies for volatile markets
- • Account for hedging costs when determining optimal ratios
- • Monitor hedge effectiveness regularly and rebalance as needed