What does a ratio of 0.75 mean?
It estimates hedge exposure equal to 75% of the portfolio value under the supplied minimum-variance assumptions. Contract size, multipliers, and trade direction still need a separate check.
Estimate a minimum-variance hedge ratio, hedge amount, and indicative instrument quantity.
Use portfolio and hedge-instrument volatility with their historical correlation.
Minimum-variance hedge ratio = correlation × (portfolio volatility ÷ hedge-instrument volatility).
Illustrative estimates use simple instrument prices without contract multipliers.
| Inputs | Result | Interpretation |
|---|---|---|
| Portfolio $500,000; price $4,200; volatility 18%; hedge volatility 22%; correlation 0.92 | 0.75; $376,363.64; 89.61 units | High positive correlation supports a substantial, but not full, hedge. |
| Portfolio $100,000; price $1,000; both volatilities 20%; correlation 1.00 | 1.00; $100,000.00; 100.00 units | Equal volatility and perfect correlation produce a one-to-one hedge. |
| Portfolio $1,000,000; hedge price $5,000; portfolio volatility 15%; hedge volatility 20%; correlation 0.80 | 0.60 ratio; $600,000 hedge amount; 120 contracts | The 0.80 correlation and volatility relationship produce a 0.60 minimum-variance hedge ratio. |
It estimates hedge exposure equal to 75% of the portfolio value under the supplied minimum-variance assumptions. Contract size, multipliers, and trade direction still need a separate check.
A stronger stable relationship can improve variance reduction. Liquidity, basis risk, cost, and changing market regimes can still leave a hedge incomplete.
Negative correlation can call for an exposure in the same direction under the formula. Verify the instrument’s quoted direction before trading.
No. Apply contract multipliers, lot sizes, option deltas, margins, and your hedge policy before placing any order.