How do you hedge futures

[shrineha]

I am doing futures trading regularly. But I still have not understood well enough about hedging them.

Just a wierd thought but if something like 11.09.01 happens and whole stock market crashes or if stock receives takeover offer at double the price , it might make me go "broke".

Hence wanted to know how exctly stalwarts here hedge their futures? Also some practical excample will be very useful for me and might be few others like me.

Kind regards,
Shrineha

 

[bunny]

Google for "Hedging with options"

 

[shrineha]

Hello Bunny,

Have already done that . But unable to find any suitable strategy for the same.

Lets say If I have February Futures portfolio for 10 Lacs, how should I hedge them with options? Should I buy NIFTY options or individual stocks options on which I have futures ? Also Options should be bought for February expiry or March expiry ? Can someone throw light on this? Survived October volatility somehow but would like to put a strategy in place to avoid nerous gap ups and gap down and potential losses because of it.

Again request for with practical example and its easier for dumb mind like me to understand it better.

Kind regards,
Shrineha

 

[anuragmunjal]

hi
If u want 2 hedge ur futures portofolio it can be done in some ways but remember when u create a hedge u have 2 give something in return of what u gain.
1. u can buy puts on the long stock / futures that u have, that will give u a risk to reward equivalent to holding a long call.
2. u can sell coverd calls on the futures u are holding, this will give u a risk 2 reward equivalent to a short otm put.
3. if the futures u are holding do not have liquid otm calls or puts, u can sell nifty otm calls or buy nifty otm puts. here u would have 2 be careful of the correct beta of the stocks/futures u hold .
4. if u do not want 2 hedge with options, u have bought futures on stocks that u assume shall go up,u can correspondingly sell futures on some stocks that u feel are weak and would go down. although this is a risky stategy, u get insulated frm an overnight news event.here too u would have 2 be very careful of the respective volatility of all the stocks on which u hold futures, whether long or short.

Last but not the least, whatever strategy u use, make a thorough study and understand the risk and rewards of that particular strategy.

hope this helps

regards

Anurag

 

[Capricorn]

Hello Bunny,

Have already done that . But unable to find any suitable strategy for the same.

Lets say If I have February Futures portfolio for 10 Lacs, how should I hedge them with options? Should I buy NIFTY options or individual stocks options on which I have futures ? Also Options should be bought for February expiry or March expiry ? Can someone throw light on this? Survived October volatility somehow but would like to put a strategy in place to avoid nerous gap ups and gap down and potential losses because of it.

Again request for with practical example and its easier for dumb mind like me to understand it better.

Kind regards,
Shrineha

If you have a myraid portfolio (different stocks) you are better off hedgng with nifty futures (no payment of premium). For that you will have to figure out the portfolio beta first..

If for eg. your portfolio beta is 1 you will have to sell NF worth 10lacs to hedge the down side.

Cheers..

 

[shrineha]

Thanks Anurag for your answer.

Quick questions again.

Wull you buy options for teh same month of expiry as futures ? or would you go for the month after? WIll you buy options out of the money ?

 

[anuragmunjal]

hi Shrineha
If I am buying options I would buy the same month expiry options. regarding ur second query,the answer is tricky, it all depends upon how much premium u r ready 2 pay and what ur risk apettite is . but if u r buying puts 2 hedge ur long futures u actually have a position equivalent 2 a long call. may as well just buy a call. u will save on the commission as well as margin.

regards
Anurag

 

[Strategist]

Just a wierd thought but if something like 11.09.01 happens and whole stock market crashes or if stock receives takeover offer at double the price , it might make me go "broke".
Kind regards,
Shrineha

In such a leveraged position you must hedge. Stock options are useless because of zero liquidity.
Since you are hedging futures the beta calculation is much higher, this is the key to the hedge. If there is a deep fall the futures will move much faster than the stock.
Would suggest you dispose the futures and buy stock instead. The potential for profit is smaller but the loss factor is very much less, given the same move.

 

[DanPickUp]

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[Placebo]

Hi. Sorry to say this but 99% of what has been written so far has nothing to do with hedging or related to it. People have mentioned strategies which are the last part of hedging.

The basic premise is to take a opposite positions in cash and derivatives market which would offset loses or reduce the impact of losses.

Lets say that you decide to hedge your portfolio with options then the following variables will have to be analyzed while building up a strategy.

1. Weighted Beta of the portfolio : In theory beta represents the volatility of the financial asset in relation to the benchmark index. The reason we use weighted beta is because the portfolio consists of more than one asset and just like the free float capitalization of the index we calculate the proportion of the major heavyweights in our portfolio. This will helps us determine which financial asset is most likely to move the value of our portfolio down. Once this is established then we take dual action to protect our entire portfolio as well as that heavyweight. We take opposite positions of that financial asset in the derivatives market.


2. Hedge Ratio : In order to take an opposite position we need to calculate something called the hedge ratio which will help us see how much quantity do we require in the derivatives market or if you are able to play with mathematical equation a person can determine how much stock should you hold using the current number of contracts in the derivatives market. Usually options are preferred for such activities and this means a good understanding of Bell Curve , St Dev ,Time Value of Options , Intrinsic Value of Options , Pricing of options either using BS Model or the Binomial Model or mis pricing of options using the above models , Calculations of Implied Volatility.

And after that strategies can be made in either futures or options.

In theory you would get a perfect hedge however in reality it does not exist neither will it ever exist. If a person is capable of setting aside some capital to protect initial capital only then the question of hedging arises till then it still comes under speculation. So far we have not taken into consideration the opportunity cost however an ideal unbiased model would take into consideration that as well.

Please dont get me wrong when i say this. Most people have no idea of what they are talking about on when it comes to options. So do not believe everything you read on these forums.The only reasonable and sensible posts i have read on options are from aw10 and dan.

Anyways , i hope this helps

Cheers
Happy Trading