Over-hedge.

Let’s take a look at what an over-hedge is.

C-Booking is not limited to partial hedging.

Another variant of C-Booking is when a broker can also choose to “over-hedge.”

This means the broker can hedge more than 100% of a customer’s position.

Over-hedge Example 1

For example, instead of a hedge trade that covers 100%, it can choose to hedge 110%.

Rather than “C-Book”, a more accurate name would probably be “A-Book+.”

Why would a broker want to do this?

If the broker thinks the customer’s trade will make a profit, it can “ride along” with the customer and make some extra profits.

Elsa opens a long 1,000,000 EUR/USD position at 1.2001, which means the broker is now short 1,000,000 EUR/USD.

Here, the broker can decide to:

1. Not hedge (B-Book)
2. Partially hedge (C-Book)
3. 100% hedge (A-Book)
4. >100% hedge (C-Book)

The broker has profiled Elsa as an informed trader and chooses option #4.

It hedges 110% of the risk.

It goes long 1,100,000 EUR/USD with an LP at 1.2000.

If it A-Booked the trade, it would’ve gone long 1,000,000.

Instead, it went long 1,00,000 plus an additional 100,000 units or the equivalent of 110% Elsa’s position size.

Elsa turns out right and EUR/USD rises.

She exits her trade for a gain of 100 pips or $10,000.

Obviously, this means the broker has a loss of $10,000.

But….notice its P&L with the LP.

Since the broker “over-hedged” and had a bigger position size against the LP, its profit from the LP exceeded its loss from Elsa.

The broker was able to “juice” its profits.

This “over-hedging” strategy is not without risks though.

Let’s see what happens when the customer loses.

In this scenario, EUR/USD falls and Elsa exits her trade at a loss of $10,000.

Obviously, this means the broker has a gain of $10,000.

But….notice its P&L with the LP.

Since the broker “over-hedged” and had a bigger position size against the LP, its loss from the LP exceeded its profit from Elsa.

This is the tradeoff if the broker’s hedge exceeds 100%.

It exposes itself to greater loss if the customer ends up wrong.

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