What is a cross hedge?

By Chizoba Morah AAA
A:

Cross hedging is when you hedge a position by investing in two positively correlated securities or securities that have similar price movements. The investor takes opposing positions in each investment in an attempt to reduce the risk of holding just one of the securities. The success of cross-hedging depends completely on how strongly correlated the instrument being hedged is with the instrument underlying the derivatives contract. When cross hedging, the maturity of the two securities has to be equal. In other words, you cannot hedge a long-term instrument with a short-term security. Both financial instruments have to have the same maturity.

Hedging is a form of investment insurance that is meant to reduce risk. Hedging does not eliminate the amount of risk involved in an investment; it just softens the negative effect on the hedger. Typically, hedging involves investing in two securities that have a negative correlation. A negative correlation means that the two securities move in opposite directions. When one security looses value, the other gains value.

For example, you could have a long position in a gold company then take a short position in a gold ETF. Because the price of the gold company's stock would move in tandem with the price of gold, it would create a cross hedge. There wouldn't be a perfect correlation, so this example would not provide a perfect hedge.

RELATED FAQS

  1. What are some of the most popular ETFs that track the Internet sector?

    Learn about leading Internet exchange traded funds (ETFs). Find out how to invest in a diversified basket of stocks from ...
  2. How are retained earnings related to a company's income statement?

    Understand what a company's statement of retained earnings represents and how it is related to a company's other financial ...
  3. What is the best timeframe to use when evaluating return on sales (ROS)?

    Understand the significance of the return on sales ratio, and learn how investors and analysts commonly use it in evaluating ...
  4. What are the most common ETFs that track the financial services sector?

    Examine common exchange traded funds that track the financial services sector and learn about past performance, expense ratios ...
RELATED TERMS
  1. Real Estate

    Land plus anything on it, including buildings and natural resources.
  2. Steve Cohen

    A trading magnate also referred to as the Hedge Fund King and ...
  3. David Tepper

    A legendary investor who specializes in distressed debt and manages ...
  4. David Einhorn

    Known for his short selling strategy, activist investor David ...
  5. Lion economies

    A nickname given to Africa's growing economies.
  6. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...

You May Also Like

Related Articles
  1. Mutual Funds & ETFs

    Buying ETFs on Margin Versus Leveraged ...

  2. Professionals

    Are Alternative Mutual Funds, ETFs Right ...

  3. Investing

    Is the Best Plan for Pot Investing 'Wait-and-see?'

  4. Charts & Patterns

    Why These Are 2015's Most-Promising ...

  5. Mutual Funds & ETFs

    Are These the Top Inverse ETFs of 2 ...

Trading Center