Short Hedge or Selling Hedge

Short hedge, also known as selling hedge, is a hedging practice mainly practiced by institutional traders, hedge funds and commodity producers to hedge against future price volatilities. In short hedge, the trader shorts a financial instrument (mostly futures and options). Selling hedge is mainly practiced for agricultural commodities but can also be practiced for other financial instruments like stocks and fixed income securities.

In short hedge, usually the trader takes short position for the futures contract which has be same underlying that the trader proposed to deliver. Fore example if the trader is proposed to deliver stocks, which he has taken long position, at a future date and is in risk of fall in price, can short a future contract which has a price at/around/above current spot price. Thus if the price of stocks fall, the price of futures contract also falls and thus the trader can close his short position with a profit with fully or partially fills his loss of his closed long position in stocks.

Short hedge is considered as a more complex strategy than long hedge. With short hedge, there is always a chance of basis risk, risk of both not getting enough profit and the loss of costs involved in futures trading. This scenario occurs when the long (holding) instrument price stays equal or around the spot trading price of shorting the futures contract.

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