Hedging
How does taking an offsetting position soften a loss, and what does that protection cost?
In plain words
A hedge is a second position taken alongside an existing one, sized and chosen so that if one loses money the other tends to gain. An owner of an asset might take a small short position, or buy a protective option, to blunt a fall.
Why it matters
Hedging trades away some of the upside, and it usually carries a running cost: fees, funding payments, or the premium paid for protection. A hedged book is steadier, but it cannot fully participate in a rally, so the choice is between smaller losses and smaller gains.
In a real week: BTC, week of 8 June 2020
In the week of 8 June 2020, BTC fell 4.15%, from 9746.99 to 9342.10, closing in the lower third of its week range. An offsetting short would have blunted that loss, and since funding averaged 0.0085% per 8 hours and positive funding runs from longs to shorts, the short would have received that payment on average; it paid only at the negative readings, dipping to -0.0038%, with a peak of 0.01%. The hedge also gave up upside, as BTC still rose 2.01% on its best day, 12 June, and reached 9992.72 on Wed 10 June.
A common mistake
Treating a hedge as free insurance that removes risk. It reduces exposure on both sides and charges a cost while it is held, so a fully hedged position neither loses nor gains much.