Hedging

Hedging is a deliberate strategy adopted to limit the potential for future losses. For example, airlines may hedge their exposure to rises in aviation fuel by the use of options. The airline might purchase a call option that gives the company the right – but not the obligation – to buy a quantity of fuel from the seller at an agreed price some time in the future. If the price of aviation fuel rises above the agreed price, the airline can exercise the option and buy at the agreed price rather than the spot price. Such hedges are expensive, so airlines may hedge only a proportion of their spend portfolio. Similarly, if a company makes most of its sales in a particular overseas country, then a natural hedge against currency fluctuations is to purchase materials from the same country. Whichever way the currencies move against each other, the buying company will either gain on cheaper materials, or make more profit on sales.