What is a Hedgelet
A hedgelet is a simplified futures contract which pays the holder a specific payoff if one particular economic event occurs before the contract’s expiration date. These events include movements in economic indicators, such as commodity prices, housing starts, or foreign exchange rates. A hedgelet is one type of binary option.
BREAKING DOWN Hedgelet
A hedgelet is simplified in that it is a binary product with limited risk. The contract either results in a payoff to the holder, or it does not, based on a particular economic situation. This simplicity makes a hedgelet an attractive investment option for a speculator with a firm opinion on a specific economic variable. Unlike other binary options contracts, a hedgelet does not offer the buyer a put or call option on an underlying asset.
Hedges have long been available to larger investors or corporations interested in speculating on or protecting themselves against, economic volatility. An airline might use a derivative contract to lock in a favorable price for jet fuel, a bank might do the same to limit losses due to interest rate movements, or a city government might lessen losses which arise from catastrophic weather events.
These hedge contracts are frequently written as part of a sophisticated package of derivatives designed to protect against various market risks. In the case of the city or bank mentioned above, the written hedge is a form of insurance.
Hedglets are priced between $0 and $10, offering the smaller investor a relatively low-risk vehicle for speculation on underlying variables. These contracts first became available in 2004 via HedgeStreet, an online exchange now known as Nadex. The Commodities Futures Trading Commission regulates Nadex.
How Does a Hedgelet Work?
An investor willing to speculate that the U.S. Dollar-to-Euro exchange rate would go above 1.25 USD/Euro might open a Nadex account and find a contract for sale at $10. This contract will result in a $100 payoff if the USD/Euro rate hits the strike point. If the rate does rise, the investor will profit $90 per contract ($100 payoff less $10 investment). If the exchange rate does not meet the strike price, the investor loses the $10 contract price.
These contracts are short term, and most expire by year’s end. Nadex does not offer the contracts directly. To buy a product like the one in this example, a second investor must have gone to Nadex and listed the hedgelet.