see hedging

Short Hedge

To "sell short" means the same thing as selling something in the futures market.  i.e. you are promising to sell an asset (stock, bond, physical good) to someone in the future at a specified price.  You might not even own that asset at the present time, but you can sell it forward (short it), which means that you will have to buy it sometime between now and then, so that you can sell it at the specified price.  So, if the price is fixed at which you will sell it in the future, what you are hoping is that the market price of that good will drop between now and that future date, so that you can buy it cheaply, and sell it at a higher price, making a profit.  Selling short is like betting on a price decrease (by selling a contract in the forward market). 

How to short hedge?

Sell in the futures market.  Sell a futures contract.

When to use a short hedge:

If you are hurt by a price decrease.  If, for example, you might have an asset that you don't want to loose in value, like inventory.  A short hedge reduces the risk of holding inventory. You reduce your inventory risk by selling futures contracts.  This is very common in business, and is used whenever someone either has, or anticipates receiving inventory.   You write a futures contract in order to "lock in" a future price for your good (this is short selling, meaning that you are protected from a drop in price).

Examples

Agricultural Example

Lets assume that you produce wheat, and you are afraid that the wheat might loose in value before you can bring it to market, then you could sell wheat (short) on the futures market. 

This is  different than writing forward contracts.  Instead, what you are selling is another asset (wheat contract) in the futures market.  So, if your physical wheat that you are growing increases in value, then the short futures contract will loose value.  But, if your physical wheat were to lose value, your futures contract would gain in value.  This is the idea of hedging...you buy another asset that moves in the opposite direction of your first asset...so the risk cancels each other out.  The idea is that by hedging, you should try to purchase / sell the exact right number of futures contracts to offset your risk of your physical asset. 

Financial Example:  Mortgages

A very common example of short hedges may occur when a mortgage broker builds up an "inventory" of mortgages before selling them to an insurance company.  The broker would be worried that a raise in interest rates could decrease the value of his inventory of mortgages.  (note that mortgages, like all bond, decrease in value when interest rates rise). 

Again, the solution will be to sell (short) a futures contract.  But, in this case he will not find mortgage for trade on a futures market, so he will look for another asset that behaves similarly to his asset.  The most common asset to use is the Treasury Bonds, which also decreases in value when interest rates rise (and increase in value when interest rates fall).  This TBond will act as a proxy for his mortgages.

He is afraid that his mortgages will lose value, so he wants to sell them short in the futures market.  Since mortgages don't trade, he instead sells Treasury Bonds short in the futures market.  That way, if interest rates rise, although he will lose money on his mortgages (inventory before he sells them to a bank), he will make off-setting money on the treasury bonds.  If he carefully plans the right number of treasury bonds to purchase, he should be able to (almost) completely insulate himself from interest rate risk. 

Covering "short" positions:

Investors who had bet that oil prices would continue falling were forced to close their positions ahead of Monday's expiry of the October oil futures contract at the New York Mercantile Exchange, traders and analysts said. The process is known as short covering.  source:  http://www.ft.com/cms/s/0/a42969f2-88e1-11dd-a179-0000779fd18c.html