Financial Derivatives (MFM845)

Hedging & Stock Index Futures

Leben Johnson Mannariat

26th Oct. 2017

Hedging & Stock Index Futures

 • 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 / Q s

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

Beta: β = Cov(Ri , Rm) / Var(Rm)

Hedging Ratio: HR = Value of Hedged Portfolio * β

Price of Future Contract

Hedging & Stock Index Futures