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Overhedging is a form of speculation.

It means intentionally hedging an amount GREATER THAN the total related risk exposure, for example by the use of a derivative instrument with a principal amount of 200% of the related risk exposure.

The effect of overhedging in this way is to create a new purely speculative position in the derivative instrument.

The size of the new speculative position is equal to the excess of the principal amount hedged, over 100%.

Example: Overhedging

In the case above, the size of the new speculative position is 200% - 100% = 100%.

In other words equal in size to the original exposure being hedged.

The new speculative position is in the opposite direction to the original exposure.

See also