Hedging Equity and Equity Futures
Equity in a portfolio can be hedged by taking an opposite position in futures. To protect your stock picking against systematic market risk, futures are shorted when equity is purchased, or long futures when stock is shorted.
One way to hedge is the market neutral approach. In this approach, an equivalent dollar amount in the stock trade is taken in futures – for example, by buying 10,000 GBP worth of Vodafone and shorting 10,000 worth of FTSE futures (the index in which Vodafone trades).
Another way to hedge is the beta neutral. Beta is the historical correlation between a stock and an index. If the beta of a Vodafone stock is 2, then for a 10,000 GBP long position in Vodafone an investor would hedge with a 20,000 GBP equivalent short position in the FTSE futures.
Futures contracts and forward contracts are means of hedging against the risk of adverse market movements. These originally developed out of commodity markets in the 19th century, but over the last fifty years a large global market developed in products to hedge financial market risk.
Read more about this topic: Hedge (finance)
Famous quotes containing the words equity and/or futures:
“If equity and human natural reason were allowed there would be no law, there would be no lawyers.”
—Christina Stead (1902–1983)
“One of the things that is most striking about the young generation is that they never talk about their own futures, there are no futures for this generation, not any of them and so naturally they never think of them. It is very striking, they do not live in the present they just live, as well as they can, and they do not plan. It is extraordinary that whole populations have no projects for a future, none at all.”
—Gertrude Stein (1874–1946)