What is hedging? The trading minute

The trader's insurance. Hedging, or coverage in good French, involves opening a position that protects another position, just as one takes out insurance on a house one does not intend to sell. The idea seems reserved for trading floors, while it is based on the same principles as those of this column, starting with short selling. Understanding hedging means understanding why some players sell without being bearish. A crucial nuance.

Hedging, the definition of a position that protects another

The principle can be illustrated with an example. You hold 1 bitcoin in a long-term portfolio and fear a downturn in the coming weeks, without wanting to sell. You then open a short position of an equivalent amount on futures contracts. If the price drops, the loss of your bitcoin is offset by the gain from the short. If it rises, the gain from the portfolio covers the loss from the short. Your net exposure is close to zero. You have locked in the price. Professionals refer to perfect hedging when both legs cancel each other out exactly, a situation more common in theory than in practice.

Hedging is therefore not a bet; it is a voluntary renunciation of potential gain in exchange for protection against loss. And this protection comes at a cost, including fees, financing of positions, and missed gains. Insurance, once again. No one gets rich with home insurance.

Case study: airlines, miners, and the CME

Hedging is as old as futures markets. Airlines have been locking in the price of their jet fuel months in advance for decades, and grain farmers sell their harvest before even planting it. Crypto has simply imported this plumbing. Bitcoin miners, whose costs are in dollars and revenues in BTC, sell a portion of their future production on Bitcoin futures at the CME, the major derivatives exchange in Chicago, to secure their cash flow.

Look at how this changes the market reading. When a miner or a fund shorts to hedge, they are not predicting a decline; they are locking in a price. Some of the short positions that inflate open interest have no opinion on the market. This is why reading gross positions without context often leads to misunderstandings.

Is hedging useful for the individual trader?

Honestly, rarely in its sophisticated form. For a small portfolio, the simplest hedge is to sell a portion of one's positions or to size one's exposure to sleep soundly. A hedge through derivatives adds costs, a risk of liquidation on the short leg, and a complexity of tracking that few individuals can profit from. The theory is elegant. The bill, less so. If you want to try, do it on a fraction of the portfolio, noting every cost down to the last cent.

To broaden the perspective, remember that institutional hedging has very concrete effects on the indicators you consult, from funding rates to derivative volumes, as part of these flows does not bet on anything. The crypto market has institutionalized itself this way, with ETFs leading the charge. Hedgers have arrived with the coverages.

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