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Hedging

A

akashgoy

Member
Hi,
This is given on pg 27, chapter 11. Can anyone please explain me both the cases with a numerical example .

Thus an investor that knows she is due to sell an asset at a particular time can hedge by taking a short futures position . If the price of the asset goes down , the investor does not fare well on the sale of the asset, but makes a gain on the short fixtures position.
If the price of the asset goes up, the investor gains from the sale of the asset but takes a loss on the futures position .

( For e.g. : future price of asset 110, asset original price 100 . What happens if asset Price goes 80 or 120)

Note:For hedging shouldn't the future position be long ( opposite) as on one hand he is selling an asset?
 
Let's say an asset you own is currently valued at 100 (ie you are "long" in that asset as you own it). The future price is 110.

You are worried that the price will fall by the time you come to sell it. You SELL a future at 110. If the price of the asset falls to 80 when you come to sell it you have lost 30 on the asset (relative to your expect price of 110). However, buy selling the future, you make a profit of 30 on the derivative. So your overall portfolio is value d at 80+30=110.

So, you are right you take the opposite position - you are currently long in the asset, so you must go short.

Note that if the price moves to 120, you can sell the asset for 120, but as you sold the future, you lose 10 (net position 110 as before).
 
Thank you for your response .

I just want to confirm as how to realizes the profit on future . Eg - the asset price moves to 80 . The person closes his position on future by going long (buying future )for spot price 80 , sells for 120 . He gets 30 from the clearing house .
And he sells the asset for 80 in the spot market thereby total value 110 .
Is my understanding correct ?
 
Broadly, yes. You take the opposite position in the future (ie BUY at 80). Realise a profit of 30 from the margin account. Sell the asset for 80.
 
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