In simple terms
To hedge is to add a position intended to reduce a risk already present. For example, price exposure may be partly offset with a futures position carrying opposite sensitivity.
Function depends on the portfolio
The same contract can be a hedge for someone who owns the underlying exposure and speculation for someone who does not. Evaluation therefore needs the initial risk, hedge quantity, horizon, and relationship between the two legs. The isolated trade does not reveal its purpose.
Residual risk
A hedge can reduce net direction while leaving basis risk—the two legs may not move together. Costs, liquidity, margin, expiry, and operational risk also remain. Hedging does not always mean eliminating exposure and does not guarantee freedom from losses; compare risk before and after under relevant adverse scenarios.
Sources
- CME Group, Understanding the Role of Hedgers — Explains using futures to manage and offset an existing price risk.
- CFTC, Futures Market Basics — Distinguishes hedgers from speculators and outlines futures obligations and risks.