1. Definition and Principles
Hedging is one of the primary financial functions of future products. It refers to using futures to hedge against the price fluctuations of underlying digital assets, thus avoiding risks caused by these fluctuations. Hedging includes long hedging and short hedging, which are suitable for customers who wish to buy or sell digital assets in the long term, respectively.
The theoretical basis of hedging: Spot and futures markets tend to move in the same direction (under normal market conditions). Since both markets are influenced by the same supply and demand factors, their prices rise and fall together. However, due to the opposite operations in these two markets, the profits and losses are opposite as well. The profits from the futures market can make up for losses in the spot market, or the appreciation in the spot market can be offset by losses in the futures market.
2. Methods of Hedging
To engage in hedging, investors can use the following method when they are concerned about a future decline in the token price that would devalue their digital assets.
For example, User A is a Bitcoin holder who has 10 Bitcoins and is worried about a potential future decline in Bitcoin price that would lead to a devaluation of their holdings. In this case, User A can invest the value of 1 Bitcoin in USDT as collateral, choose 10x leverage, and open a short future on the Aibit platform to hedge the risk.
Assuming the current BTC price is $1,000 per coin, after a period of time, the price drops by 10%. User A's BTC holdings would have decreased in value by $1,000. However, the profit from the short future opened on the Aibit platform would be $1,000 * 10 * 10% = $1,000. Therefore, while holding BTC, the future profit offsets the loss from the spot market decline, achieving risk hedging.
3. Common Issues with Hedging
1) How to determine the order amount for hedging?
The value of the short position should be equal to the value of the tokens held.
2) How much margin should be prepared?
In hedging, the margin is mainly prepared to prevent liquidation. Therefore, more margin is better, but it also depends on capital utilization, which can be determined based on the current market volatility and the time required to add margin.
For example, if you believe that BTC will not experience a 20% price drop within an hour and you can add enough margin within that hour, then the margin ratio can be controlled by 300%. However, if you are afraid that you won't be able to add enough margin within an hour and it may take 12 hours or more to add the margin, and you also fear a 30% price drop in BTC during that time, then the margin ratio may need to be controlled at 400% or even higher.
3) When should you close the position and stop hedging?
This depends on the investor's expectations and the type of futures involved. For example, if you expect it to be one month, and you need to lock in the value of your Bitcoin during that month, you should close the position at the end of the month and avoid taking unnecessary risks due to greed for market trends.
If you are participating in a delivery future with a specified delivery date, pay attention to the delivery date. If the future is profitable, take the profits. If you have losses for the month, add more margin. After the delivery is completed, you can continue hedging based on your own situation.
4) Does hedging completely eliminate risk?
Hedging can generally offset the risk of price fluctuations in the spot market, but it cannot completely eliminate risk due to the existence of the "basis". To have a profound understanding and application of hedging to avoid price risks, it is necessary to grasp the basis and its fundamental principles.
The basis refers to the difference between the spot price and the futures price: Basis= Spot Price - Futures Price.
The basis is a dynamic indicator that reflects the actual operational changes between the futures price and the spot price. The basis can be positive or negative, mainly depending on whether the spot price is higher or lower than the futures price. If the spot price is higher than the futures price, the basis is positive, also known as a forward premium or spot premium. If the spot price is lower than the futures price, the basis is negative, also known as a forward discount or spot discount.