Understanding Rolling Hedges: A Risk Management Strategy

What is a Rolling Hedge

A rolling hedge is a strategy for reducing risk that involves obtaining new exchange-traded options and futures contracts to replace expired positions. In a rolling hedge an investor gets a new contract with a new maturity date and the same or similar terms. Investors take a rolling hedge position when a contract expires. The rollover process will vary by the type of derivative product the investor is invested in.

BREAKING DOWN Rolling Hedge

A rolling hedge requires a hedged position to be in place before a renewal can occur. Rolling hedge positions are often used in alternative investment portfolios that integrate options and futures into their investment strategy. Options and futures can be used to mitigate the risk of significant price volatility and to potentially profit from speculation.

Hedging Contracts

Hedging contracts require greater due diligence than standard investments. Hedging products can not be transacted through all standard trading platforms and clearing houses. Therefore, investors must identify the specific type of instrument that fits their investing objective and identify the trading platform where the hedging product can be traded. Trading options and futures typically requires a designated account or trading unit with specific parameters and margin requirements.

Contract Rollover

Once a hedged position has been established by an investor, renewing it is basically a simple process. Investment in hedged products is often used by advanced investment professionals because of the additional costs and risks associated with hedging. An investor buys an option or futures contract at a specified price and may also incur trading fees. Hedging products also have margin requirements. Margin requirements require an investor to deposit collateral for a portion of the investment they plan to make at the specified maturity date. Margin percentages vary and investors must keep collateral levels based on the changing value of the investment.

In a rolling hedge an investor seeks to keep the hedge position for their portfolio. In some cases, an investor must close the hedged position (also called "de-hedging") or settle collateral positions at expiration to roll the hedge with a new position. In many cases the contract will have an automatic renewal which allows collateral positions to be continuously maintained.

A rolling hedge allows an investor to maintain their hedged position with a new maturity date if their contract is not exercised. A number of factors may be important for due diligence when a hedge is rolled. Some traders may seek to identify arbitrage opportunities that may occur around a contract’s expiration date. If a rolling hedge requires manual renewal, an investor’s collateral position may be a consideration. Derivative contracts with automatic rollovers often see less price volatility at expiration. Contracts with automatic renewals also provide for simplified collateral management and margin maintenance. In some cases an investor may like to exercise options at expiration and enter into new contracts to keep the underlying position hedged for the future.

For examples and more details on rolling hedges for e-mini contracts see also: E-Mini.