How Can a Hedger Attempt to Minimize Basis Risk?
A hedger can minimize basis risk by selecting a futures contract whose underlying asset and delivery location are as closely matched as possible to the asset being hedged. They should also choose a contract expiration date that closely aligns with the date the physical asset is expected to be bought or sold.
Finally, monitoring the historical basis and adjusting the hedge ratio can help optimize the hedge.
Glossar
Basis Risk
Exposure ⎊ The core of basis risk within cryptocurrency derivatives, particularly options, stems from the imperfect correlation between the price movements of the underlying asset and its derivative contract.
Hedge Ratio
Calculation ⎊ The Hedge Ratio quantifies the necessary size of a derivative position required to offset the price risk inherent in an underlying asset or portfolio, representing the change in the derivative's price relative to the change in the underlying.
Historical Basis
Provenance ⎊ Historical Basis, within cryptocurrency and derivatives, signifies the documented chain of ownership and price discovery events influencing an asset’s valuation, crucial for establishing legitimate market references.
Delivery Location
Architecture ⎊ The delivery location is often defined by the underlying smart contract architecture in decentralized derivatives.
Expiration Date
Deadline ⎊ The Expiration Date marks the definitive deadline for the option contract, after which the right to exercise or the obligation to perform ceases.
Futures Prices
Discovery ⎊ These prices represent the market's consensus expectation for the value of an underlying asset at a specified future delivery date.