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Hedging Strategies using Futures - Coggle Diagram
Hedging Strategies using Futures
Risk Exposure
Long
Own asset and want to sell it
Risk: Spot price decreases
Short
Risk: Spot price increases
Don't own asset and want to buy it
Short Hedge
Sell asset in future.
Benefits from price falls.
Effective price=F1 + Basis2 [S2 - F2]
If Basis increases effective price increases (desirable)
If Basis decreases effective price decreases
Long Hedge
Purchase asset in future
Benefits when price rises
Effective price = F1 + Basis2 [S2-F2]
Decrease in Basis = Decrease in effective buying price (desirable)
Increase in Basis = increase in effective buying price
Basis Risk ( St - Ft )
Negative St < Ft
Uncertainty on sale of asset date (St)
Positive St > Ft
Uncertainty on when futures contracts close, usually before maturity (Ft)
Cannot be eliminated
Cross hedging
Minimising basis risk
choose a delivery month close as possible but after the hedge expiry
when cross hedging chose an asset with a high correlation
Reasons for Hedging
Short term protection for portfolio
Uncertainty about market performance
unfavorable outcomes less unfavorable
Favorable outcomes less favorable
Optimal Hedging ratio
Optimum number of futures Contracts
