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Hedging with futures – Ch.3
Lecture outline
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Introduction to hedging strategies using futures
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Long/short hedging
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Hedging outcomes
Week 3 - Hedging with
futures
FINS 3635 Options, Futures, and
Risk Management Techniques
1
•
basis risk
•
hedge ratios
Hedging with Futures
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Use a futures position to reduce or eliminate the risk of the
underlying asset price fluctuations.
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What position (Long or Short)?
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How many contracts (hedge ratio)?
Week 3 - Hedging with
futures
FINS 3635 Options, Futures, and
Risk Management Techniques
2
•
totally hedged (hedge ratio =1);
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partially hedged (hedge ratio<1);
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overly hedged (hedge ratio >1)
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The size of a futures contract and the relationship between
spot and futures prices during the hedging period have
impact on the hedge ratio.
Example of Long Hedge
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A long hedge is a hedge involves a long position in futures
contract to offset the short position in underlying asset.
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Assume that it is now Mar 15. An investor needs to buy 100
shares of IBM stock on Dec 15.
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Risk: spot price fluctuation on Dec 15
Week 3 - Hedging with
futures
FINS 3635 Options, Futures, and
Risk Management Techniques
3
•
Strategy to reduce risk: buy IBM stock futures with
Dec.
delivery
(note that size of the futures contract is 100 and
suppose that futures price is $98 per share now)

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