What Is the Concept of a “Cross-Hedge” and How Does It Introduce Basis Risk?

A cross-hedge is a strategy where an asset is hedged using a derivative on a different, but highly correlated, underlying asset. For example, hedging an altcoin position with a Bitcoin option.

Basis risk is introduced because the correlation between the two assets is not perfect (less than 1). If the altcoin price moves differently from the Bitcoin option price, the hedge will be imperfect.