The ratio of the value of long or short futures contracts to the value of the cash commodity being hedged. The hedge ratio is generally calculated to minimize basis risk. i.e., the volatility of the basis (as measured in the difference between the futures price and spot price).

Hedge ratio= value of futures position/ value of cash commodity

Also:

Hedge ratio= futures quantity/ cash quantity

Hedge ratio= futures price/ cash price

This ratio may also be used in its inverted version (i.e., hedge ratio = cash price/ futures price).

It expresses the number of futures contracts required to offset a change in the value of the underlying cash commodity or cash position with a corresponding change in the futures position. The calculation works well when the two positions (cash and futures) have similar characteristics.

The two components of the ratio may also be expressed in basis point value (BPV):

Hedge ratio = (BPV * futures price)/ (BPV * spot price)

The BPV expresses the contract price change corresponding to a 1 basis point (bp) change in the yield.

This ratio involves the so-called a naive hedge (which helps minimize risk if the basis remains static- i.e., the change in basis is zero). Hence it is also known as a naive hedge ratio.