Equity index hedging is a risk management tool used by many investors to protect their equity portfolios in the event of unplanned or negative events in the market. Equity index hedging can be utilized against the S&P, Nasdaq, Dow, and Russell index markets. In the event of a market correction, investors can sell the corresponding futures contract to hedge a portion, or all of their portfolio without liquidating their core holdings. If the market continues to fall, the contracts sold become profitable resulting in a gain helping to offset the loss that the equity portfolio is assuming.
Every investor is different so deciding how much of your portfolio to hedge is a personal preference that will likely be based on your risk tolerance and investing time frame. For example, if we assume an investor has a $2,000,000 equity portfolio and they wanted to hedge 30% of the portfolio, they would need protection on $600,000. Once you determine how much of your portfolio you want to hedge you can then figure out how many contracts to sell.
The value of an equity index futures contract depends on the underlying price of the market. For this example, we will use the S&P 500 futures contract with a price of 2830 which would represent a value of $141,500 per contract. If you were going to hedge $600,000 in equity exposure, you would need to sell approximately 4 contracts ($600,000 amount you are hedging / $141,500 the amount of the current contract = 4.24).
In the above example, let’s assume the market has a 15% correction and the investor’s portfolio in equities is down $300,000 in value. The 4 S&P contracts that are sold as a hedge have increased by 15% resulting in a gain of $21,225 per contract for a total gain of $84,900 reducing the overall decrease in the portfolio.
Wisdom Trading can provide full service hedging strategies for your portfolio. Contact us today to learn more about protecting your equity investments against corrections.
Corporate hedging is also available for business looking to hedge with inventory or sales against future price fluctuations.