Five smart things to know about 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 Rs 100 and she sells the index futures at Rs 100.
4. On the future date, when she actually sells her equity portfolio, assume that the value has fallen to Rs 80 due to a market crash.
5. She will lose Rs 20 on her sale of equity, but gain Rs 20 from her futures position. The returns are to the desired value of Rs 100. This value is protected irrespective of the market fluctuations.