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In managing Equity Risk, a portfolio of Stocks can be hedged via Derivatives. The Hedge Ratio is the hedged position as a percent of the total Portfolio, expressed as a percent.

In managing the Equity Risk in a Stock Portfolio, a Hedging Strategy could be incorporated, to mitigate the potential losses during a market drawdown. Risk Management is not necessarily Black and White, depending on the overall strategy for Equities. Therefore, once a view as to the direction of the Market has been discussed and decided, the correct Hedge Ratio can be incorporated. A Hedge Ratio can go from 0%, no hedging or Bullish, to 100% or fully hedged Bearish and all stops in between. The most common hedge positions are constructed using Stock Index Futures or Stock Index Put Options. There is an argument for Hedging via a portfolio of low correlated Stocks. This is more of an Investment Strategy. In a Drawdown correlations tend to move towards 1. A Short Position in Index Futures will be negatively correlated.

The Hegde Ratio is calculated via the following formular.

Hedge Ratio = Market Value of (Derivatives / The Stock Portfolio)

Therefore, as the two known values are, the Stock Portfolio and the required Hedge Ratio, the formular can be easily rearranged.

Derivatives = Hedge Ratio X The Stock Portfolio

OK, if a Stock Portfolio is to be fully hedged, why not just sell? Keep in mind the Derivatives market is much more liquid and inconspicuous for Institutional Investors. The possible liquidation of a large Institutional Stock portfolio, can move the Market Price for individual Stocks. Further, after a couple of strong directional trades, the other operators in the Market will soon understand the trading position. This places the liquefier of Stocks at a disadvantage.

The Hedge Ratio will keep moving as prices change. A hedge position needs to be actively managed. Both the Derivative positions and the Portfolio value need to be Marked to Market at least daily.

Be prepared to calculate, calculate, calculate.

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Warren William

Meet the author behind Smartest-Data. Warren William has a career in Finance and Investments extending over 35 years, both on the Buy Side and Sell Side. His most recent roles include, developing Institutional Risk Management Programs for managing Equity and Fixed Income Risk.  Prior to this Warren William work in Alternative Investments, in Investment Management and as a Buy Side Equity Analyst. Warren William brings a wealth of knowledge and expertise to the table, providing in-depth analysis and commentary on the latest trends in the Stock Markets. Contact information: or Telegram +393339034488

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