How Does a “Cross Hedge” Increase Basis Risk?
A Cross Hedge is used when a futures contract is not available for the exact asset being hedged, so a futures contract on a related asset is used instead. This increases basis risk because the prices of the two different assets may not move perfectly in tandem.
The correlation between the hedged asset and the futures contract is imperfect, leading to potential unexpected losses.
Glossar
Cross Hedge
Hedge ⎊ A cross hedge involves mitigating risk exposure in one asset by taking an offsetting position in a different, but correlated, asset.
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.
Futures Contract
Leverage ⎊ Futures contracts in cryptocurrency represent agreements to buy or sell an underlying asset at a predetermined price on a future date, functioning as a derivative instrument that allows for amplified exposure without immediate asset ownership.