Hedging is the process of reducing the risk of the business for two contracting parties. In the process the party can transfer the risk of fluctuating prices of assets. Let's take an example: If a farmer will sell his wheat product to another party there is risk of price changes. But if the two parties will get into a contract, the farmer will be secured that price will not change. Moreover, the other party will be secured of constant release of the wheat.
But there is a great risk for two parties due to the changes of the weather. There is a great risk of the wheat supply when the weather changes and the plantation of the wheat are damaged. Moreover, there are clearing houses or finance companies that will help to get the risk of the counter parties.
At the moment the contract is made, the parties lose the risk but there are additional risks that must be known. First, additional risk to the selling party happens when the price of the wheat goes high. It is hard for the party to gain additional income with the price increase. On the other hand, the buying party acquires risk when the price goes down.
In the derivatives insurance, the insured party gets the necessary security from the insurer. But the insurer sees the market as part of a risk management. The insurer finds an opportunity to gain from the contract because he sees differently things. Instead of risk, gain may be acquired when the market changes. It works the same with the bonds and stocks.
This form of insurance relies more in speculative trading. It anchors on the market activity. Business insurance like this is very risky and entails much look out of the market movement.
