hedge ratio
The proportion of a position that is offset by a hedge, indicating the degree to which risk has been reduced through an offsetting position.
Example
“A hedge ratio of 0.8 means 80% of the position's risk has been offset by the hedging instrument.”
Memory Tip
HEDGE RATIO = what percentage of risk is covered. 1.0 = fully hedged. 0 = unhedged.
Why It Matters
Understanding hedge ratio helps you assess how much of your investment risk you have actually reduced through protective strategies. This matters because a partial hedge may still leave you exposed to significant losses, so knowing your true protection level is essential for making informed decisions about whether you need additional safeguards.
Common Misconception
Many people assume that having any hedge in place means their risk is fully eliminated or neutralized. In reality, a hedge ratio of 0.5 means only half your position is protected, leaving the other half vulnerable to losses, so the percentage matters significantly.
In Practice
Suppose you own 1,000 shares of a stock worth $100 each, representing a $100,000 position. You buy put options protecting only 500 shares as downside insurance, creating a hedge ratio of 0.5. If the stock drops to $80, your unhedged 500 shares lose $10,000 in value while your protected 500 shares maintain their $100 strike price protection, demonstrating that your overall position is only partially protected.
Etymology
HEDGE (risk offset) RATIO (proportion). The RATIO of the HEDGE to the overall exposure.
Common Misspellings
Protect your assets with the right insurance
Related Terms
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See Also
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