Protection = (Unhedged Loss - Hedged Loss) / Unhedged Loss
Hedged loss includes the cost of the hedge plus the loss on the unhedged portion of your portfolio.
Portfolio hedging is a risk management strategy that involves taking offsetting positions to protect against potential losses in your investment portfolio. Think of it as insurance for your investments -- you pay a premium (the hedge cost) to limit your downside exposure during market downturns. Common hedging instruments include put options, inverse ETFs, and futures contracts.
The hedge ratio determines what percentage of your portfolio is protected. A 100% hedge ratio means your entire portfolio is covered, while a 50% ratio means only half is protected. Higher hedge ratios provide more protection but also cost more and limit upside potential when markets rise.
The effective protection percentage shows how much of the potential loss is offset by the hedge after accounting for the cost of hedging. A higher effective protection means the hedge is doing a better job of shielding your portfolio. The net savings figure represents the dollar difference between what you would lose without the hedge versus with it.
Compare the hedge cost against the net savings to evaluate whether hedging is worth the expense. If the expected decline is small, the cost of hedging may exceed the potential savings, making it counterproductive. Hedging is most valuable when protecting against significant market corrections or crashes.
This calculator provides a simplified analysis of hedging impact. In reality, hedging strategies involve complex factors such as basis risk (the hedge may not perfectly track your portfolio), time decay on options, margin requirements for futures, and counterparty risk. The actual cost of hedging can vary significantly based on market conditions and the specific instruments used.
Remember that hedging reduces both downside risk and upside potential. In rising markets, a hedged portfolio will underperform an unhedged one by the cost of the hedge. The decision to hedge should be based on your risk tolerance, investment horizon, and market outlook. Consult with a financial advisor before implementing hedging strategies in your portfolio.