Stock Futures for Hedging

 

Hedging with futures





1 Hedging is an investment strategy to protect against a negative event. A good hedge reduces the impact of the event if it happens.

2 If an investor needs money two months from now and fears a fall in equity during this period, she can hedge this risk by selling equity index futures today.

3 Assume that her portfolio's current value is `100 and she sells the index futures at `100.

4 On the future date, when she actually sells her equity portfolio, assume that the value has fallen to `80 due to a market crash.

5 She will lose `20 on her sale of equity, but gain `20 from her futures position. The returns are to the desired value of `100. This value is protected irrespective of the market fluctuations.

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