• Hedging Futures It is the process of mitigating risk exposure.
Long Hedges: Short Spot, Long Future, fear is price increase
Short Hedges: Long Spot, Short Future, fear is price reduction
Cross Hedging: When future is not identical as underlying or
different quantities or maturities. There should be a correlation between underlying and the future, else risk increases. BASIS = Spot – Future: Strengthening of BASIS = When Spot is more than Future, Weakening of BASIS = When Future is more than Spot,
Change in BASIS: ∆b t, T = ∆S t, T - ∆F t, T
Hedging & Stock Index Futures
• Hedging Futures
Hedging Effectiveness: HE = 1 - σ 2 (b t, T ) / σ 2 (S t)
Hedging Ratio: HR = Futures Position / Cash Position = Q F /
Qs
Hedging Ratio: HR = ∆S / ∆F
Number of Futures Contract: NFC = Q s / Q FC * HR
Hedging & Stock Index Futures
Stock Index Futures: Ft, T = St (1 + C) With Dividends: Ft, T = St (1 + C) – ∑ Di(1 + Ri) Ft, T = St + St (Ci - Dt) (T-t)/365