HEDGING BENEFITS

There is a rising evolution that equity and commodity markets are interrelated. Another observation is the relationships between commodities and equities have generally increased since the early 2000s during which time commodities have been progressively used by traders for speculation and asset managers for diversification. This process is called financialization. While numerous studies have examined whether the time-series properties of commodity returns have changed since the early 2000s or been inclined by “financialization”, the outcomes are mixed. Thus, the foundation of the growing correlation between energy commodities and equities may not be the “financialization” of commodities but rather may replicate other factors.

Generally, hedging involves taking a long position in one asset and a short position in another asset. In our case, taking a long position in equity cash and a short position in commodity futures, the rise in correlations proposes that a move in equity price will be better counterpoise by a short position in the commodity. Thus, the hedge becomes more effective.

Hedging is a normal practice followed in the stock market by investors to protect themselves from the losses that may arise from market fluctuation. We can say that hedging is a kind of insurance that helps the investor to reduce their losses and to achieve consistent growth. The method of hedging is also followed at an institutional level by fund and portfolio managers to lessen their exposure to different kinds of risk and to decrease its negative effect.

Benefits of hedging:

  • The main advantage of hedging is that it limits the losses of the investor.
  • It protects the returns of the investor.
  • It increases the liquidity of the markets as hedging stimulates the investor to trade different markets of commodity, currencies and derivative markets.
  • The hedging suggests a flexible price mechanism as it requires a very less margin outlay.

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