How Can We Hedge Futures in the Stock Market?

Derivatives can help investors hedge against rising prices or inflation. While futures themselves prevent potential losses, they allow traders to take a step further and hedge them. Hedging with futures allows investors to avoid potential losses and enjoy attractive returns. Futures investments can be hedged by other futures, options, and other instruments. Continue reading to understand how to hedge futures in the stock market.

Topics Covered:

• How to Hedge Futures in the Stock Market?
• Situations Where You Can Use Hedge Futures Effectively
• How to Check Future Contract Prices?
• What is the Difference Between Swaps and Futures?
• Conclusion

How to Hedge Futures in the Stock Market?

Hedging futures refers to using futures contracts to prevent potential losses in the future. It helps investors prevent their portfolios from rising prices or inflation. The basic step for most investors is to hedge their stock positions with the help of futures. You already know that futures allow investors to buy/sell the underlying asset at a predetermined price on the expiration date. Let us say you suspect that the prices of a particular stock will fall in the future. In such a case, you can hold a futures contract to sell the stock at a strike price. When the market price of the stock is less than the strike price on the expiration date, you can exercise the futures to sell the underlying asset at a better rate.

Futures contract hedging also involves balancing long and short contracts to minimise potential losses. You can also hedge futures by combining options contracts. For instance, you can hedge a short futures position by purchasing a put option. Similarly, investors can indulge in long hedging to offset the loss of one instrument with the profit gained on the other.

One can sell futures to protect the risks associated with equity positions. While futures contracts are exercised on the expiration date, options are highly flexible. Options holders can also choose to ignore the contract on the expiration date. For the same rationale, some experienced investors prefer options for hedging equity positions.

Investors must be familiar with different types of futures/options to implement hedging strategies. Also, one must understand the concept of taking long and short positions in the market. You can use futures to hedge equity positions or other futures investments. Besides futures and options, investors can use stop-loss orders and other facilities to hedge equity positions.

Situations Where You Can Use Hedge Futures Effectively

Do you want to implement effective hedging strategies? If yes, you must understand the scenarios where you can use hedge futures. The first situation is when the stock price starts plummeting. When you see a stock’s price falling, you can invest in futures contracts. You can take a short position with futures that allows you to sell the stock on a future date. Even when the market price falls, you will sell stocks at a predetermined strike price, which will be more than the market price.

Some investors might identify risks on a macro level. Let us say you suspect that the stocks of all IT companies might plummet due to a new regulatory framework or change in policy. In such a case, you can use futures based on IT sector market indices. It will allow you to hedge against risks in the entire market.

Hedging futures is not always used to prevent downsides. Many investors prefer locking their profits with the help of futures and options. When prices fluctuate rapidly, investors prefer locking their profits by buying/selling futures.

How to Check Future Contract Prices?

You can check the live prices on the respective websites of stock exchanges for hedging with futures. For instance, you can visit the official website of the National Stock Exchange (NSE) and check the live prices of futures contracts.

Investors can also rely on trading platforms provided by stockbrokers to check future contract prices. You can search for futures contracts based on the underlying security. You must enter the stock, market index, or other underlying security to search for available futures. The trading platform will also allow you to purchase futures directly through your brokerage account.

What is the Difference Between Swaps and Futures?

Before hedging futures with options alike, you must understand a few basics. Beginners often confuse swaps with futures. Both are financial contracts or derivatives, but there are some dissimilarities. A swap is a contract representing an agreement between two parties to exchange assets or cash flows on a future date. On the other hand, futures allow investors to buy/sell securities on a future date at a predetermined price.

Futures are standardised contracts available on stock exchanges. On the other hand, swaps can be customised based on the preferences of involved parties. Swaps are Over-the-counter (OTC) contracts usually settled in cash. Futures are settled through both cash and physical delivery (in the case of commodities).

Swaps are usually based on interest rates or currencies. On the other hand, the underlying assets for futures can be stock, market index, commodity, etc. You must not confuse bilateral contracts or swaps with futures, which are standardised contracts.

Conclusion

Hedging with futures can help investors minimise portfolio risks. You can protect your investments from plummeting prices or inflation with futures. Besides hedging with futures, you can enjoy added flexibility with options. One can find futures and options contracts on the official websites of stock exchanges. However, it is better to seek help from a reputed stockbroker and gain access to a trading platform. You can open a brokerage account online and start trading derivatives today. Learn more about futures trading now!