What is a Hedgelet?
A hedgelet is a binary futures contract whose payoff is conditional upon a specific economic occurrence.
How Does a Hedgelet Work?
A hedgelet is a futures contract which hedges that a specific event (for example, movements in interest rates, commodity prices, or exchange rates) will have occurred on or before the contract's expiration date. Hedgelets are binary contracts, meaning that they have only two possible outcomes: a predetermined cash payoff or no payoff. Hedgelet prices are based on other prices of hedgelets in their market. Profits fluctuate in terms of the market price relative to the payoff stated in a given contract.
For example, suppose a foreign-exchange hedgelet priced at $10 per contract promises to pay $100 if the U.S. dollar-to-U.K. pound sterling exchange rate reaches or exceeds 1.800 USD/GBP by December 31, 2011. If this rate increase occurs, a contract holder makes $90 in profit ($100 payoff minus $10 contract premium). If the rate fails to reach this level, a contract holder receives no payoff and loses his/her $10 investment.
Why Does a Hedgelet Matter?
Hedgelets are low-risk investment tools for individuals with strong convictions about the direction of specific economic indicators. They offer a way for investors to directly speculate on a variety of financial and economic outcomes. However, the most unique aspect of hedgelets is their simplicity. They offer investors a straightforward 'yes' or 'no' position to take on a specific event or condition occurring at the time of the contract's expiration.