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Hedge
A strategy employed in the futures, options and warrants markets to reduce risk.
Traditionally a commodity producer (say, a cocoa grower) would agree to sell his goods at a stated price at a stated time in the future, and the user of the commodity (say, a chocolate manufacturer) would agree to buy them. By agreeing on a price, quantity and delivery date, they introduce certainty into their operations and reduce risk. For the producer, the risk would be that prices drop, and for the processor that they would rise.
The same strategy carries over into the financial markets. Options and warrants can be used to hedge a portfolio position. In the case where shares have been sold, for example, the purchase of equivalent call options (the option to buy shares) means that if the shares rise in price, a corresponding rise in the value of the option will offset the notional loss expected on the underlying shares.
Submitted by: admin
Added: Sat May 20 2006
