Hedge Contracts in Crypto: Mitigating Market Risk
Hedge Contract is a form of insurance that investors use to hedge against the risk of financial loss. A hedge is usually designed to protect against price fluctuations in the market.
What is Hedge Contract?
A hedge is an investment position aimed at offsetting potential losses or gains that could be caused by a companion investment. Simply put, a hedge is used to hedge an initial investment risk.
The principle of the use of derivatives (options, futures and swaps) or synthetic instrument (forwards, futures and swaps) is generally used for this purpose.
It is also possible to use hedging to protect against exchange rate fluctuations and other risks.
Hedge contracts are derivatives that are similar to forward contracts, but with some important differences.
A forward contract is an agreement that involves two companies to purchase and sell one or more items of the same kind of goods, services or products at agreed prices at any time in future. It provides for you to lock in your cost of this good or service, as well as give it a chance to get advantage from its price if there is an upcoming rise in demand on the market with great profitability.
The Forward contract is a hedging instrument that involves the sale of an object, such as a security, at a specific price and delivery on a specific date. Suppose you own several oil wells in California and are concerned that the price of oil will fall before you can make your next delivery. You can purchase forward contracts with guaranteeing that you will receive $100 per barrel regardless of the market value at the time of shipment.
Futures contract. An agreement between two parties to buy or sell a commodity or financial instrument at a specific price at a specific time in the future or at an agreed date in the future. The buyer of the futures contract takes a long position and the seller a short position. This transaction is aimed at reducing risk by fixing the price before you actually need to buy or sell a commodity or financial instrument. Futures contracts are standardised, making them easy to trade on exchanges. Both parties agree on the quality and quantity of what will be exchanged. Many commodities are traded on futures exchanges, such as agriculture, metals and crude oil.