Hedge cost
What does protection actually cost a trader, in regular payments and in gains given up?
In plain words
Hedge cost is the total price of reducing risk on a position. It has two parts: regular payments such as funding, the eight-hourly exchange between long and short perpetual futures holders, and forgone gains, because protection usually moves against you when the asset rises.
Why it matters
Protection is never free. A hedged book can survive a fall and still lose money, through payments made over the holding period or through the upside it gave up. Both parts must be weighed before the protection is needed.
In a real week: ETH, week of 8 March 2021
In the week of 8 March 2021, ETH rose 7.05%, closing at 1848.1 from an open of 1726.46. Average eight-hour funding was 0.0724%, peaking at 0.1552%. That 7.05% gain is the upside a short hedge leg would have forgone that week, while positive funding meant that leg received between 0.0111% and 0.1552% per eight hours, an offset counted against the missed gain.
A common mistake
Counting only the funding payments as the cost of protection. The larger component is often the upside the hedged position cannot capture.