Hedge Ratio

The hedge ratio shows how much protection a hedge provides. A hedge ratio of 1, or 100%, means the whole exposure is hedged. A ratio of 0.5 means half is hedged.

In practice, the right hedge ratio depends on how closely the hedging instrument moves with the asset being hedged. For example, an investor with a share portfolio worth 10,000,000 and a beta of 1.2 relative to a stock index would need to sell index futures with a notional value of about 12,000,000 to hedge against market movements, because the portfolio tends to move 1.2 times as much as the index.

In options, delta is used as a hedge ratio, showing how many shares are needed to hedge each option. In currency hedging, companies often choose to hedge a portion of their expected foreign currency cash flows, such as 70%, balancing protection against flexibility.

Hedge ratios may need to be adjusted over time as relationships between assets change. Choosing a hedge ratio involves trade-offs between reducing risk and the cost of hedging.