Hedge Ratio
The precise number of derivative contracts required to neutralise a position's sensitivity to market moves.
Definition
The hedge ratio is a number that quantifies how many units of a hedging instrument are needed to offset the risk of an existing exposure. It is the bridge between a position's sensitivity to market moves and the size of the protective instrument required. In options, the hedge ratio equals the option's delta — a call with delta 0.50 requires 0.50 units of the underlying (or an offsetting option) per contract to be delta-neutral. In equity portfolio management, the hedge ratio is computed using beta to determine how many Nifty or Bank Nifty futures contracts offset the portfolio's systematic risk. The concept appears in futures hedging of commodity exposures on MCX too, where the hedge ratio accounts for the correlation between the physical commodity and the futures contract.
Why it matters
A poorly computed hedge ratio leaves residual risk — you think you're protected, but you're only partially covered. An over-hedged position creates a net short exposure that can produce losses if the market rallies instead of falling. In Indian markets, hedge ratio discipline is especially important around monthly and weekly expiry when gamma surges and delta changes rapidly, requiring frequent re-hedging. Institutional traders on NSE — proprietary desks, FII derivatives books — rebalance delta-neutral positions continuously throughout the session. Retail traders approximating this with manual adjustments need to understand that the hedge ratio is not static: it shifts as the underlying moves, as time passes, and as implied volatility changes. Budget days, RBI policy announcements, and quarterly results are known gamma-expansion events where a stale hedge ratio can expose significant risk within a single session.
Formula
Delta hedge ratio (options):
Contracts needed = Position size ÷ (Delta × Lot size)
Beta hedge ratio (equity portfolio vs index futures):
Lots needed = (Portfolio Value × Portfolio β) ÷ (Index Level × Lot size)
Minimum-variance hedge ratio (futures on correlated assets):
h* = ρS,F × (σS ÷ σF)
where ρ is the correlation between spot and futures returns, σS is spot return volatility, and σF is futures return volatility.
Example
Suppose you hold a portfolio of Indian mid-cap stocks worth ₹50 lakh with a weighted-average beta of 1.4 relative to Nifty. You want to hedge the full market risk ahead of the Union Budget announcement. Nifty is at 24,500 and each Nifty futures lot covers 25 units, so notional per lot = ₹6,12,500. Hedge ratio = (₹50,00,000 × 1.4) ÷ ₹6,12,500 = ₹70,00,000 ÷ ₹6,12,500 ≈ 11.4 lots. You would short 11 or 12 Nifty futures contracts. If Nifty falls 2% after the budget, you lose roughly ₹1,40,000 on your stock portfolio (50L × 1.4 × 2%), but gain approximately ₹1,35,300 on 11 short lots (24,500 × 0.02 × 25 × 11). The residual is basis risk, not market risk — a manageable and expected outcome of a correctly computed hedge.
Compute your hedge before the next big event
TradePulse shows live delta, OI, and index levels to help you size F&O hedges accurately before volatility spikes.