The hedge ratio determines the optimal proportion of a position that should be hedged to minimize risk exposure. Calculated using statistical methods like regression analysis or correlation coefficients, the hedge ratio considers the relationship between the asset being hedged and the hedging instrument. A hedge ratio of 1.0 indicates equal and opposite positions, while ratios above or below 1.0 suggest different optimal proportions.

Hedge ratios change over time as market conditions and correlations evolve, requiring periodic recalculation and position adjustments. Factors affecting hedge ratios include volatility changes, correlation shifts, and basis relationships between cash and futures markets. Dynamic hedging strategies continuously adjust hedge ratios to maintain optimal risk reduction efficiency.

Real-world example: A copper mining company calculates a 0.85 hedge ratio for its copper production, selling futures contracts equal to 85% of expected production to optimise the trade-off between price protection and profit participation.