T
TheOke
Member
I'm wondering about how valid the statement in the ST5 notes about the minimum variance hedge ratio is:
The notes state that if you are hedging an index or share with future contracts on the identical underlying (same term as well), then the hedge ratio is 1.
Surely this cannot be the case. Future contracts are margined daily which leads to the profits acrueing daily. This being the case, a future contract on the same underlying share is far more sensitive to movements in the share. The ideal hedge ratio surely would be the present value of 1, not 1.
The textbook Options, Futures, and Other Derivatives (6th edition, J. C. Hull), page 348 gives an explanation and a formula. The formula is that if H units of the underlying asset are required to hedge a position, then H*e^(-rT) future contracts would be required to hedge the same position. Hence in the case in ST5, if the underlying was a single share, then e^(-rT) futures would be the ideal minimum hedge ratio, not 1?
Do the notes mean to say forward contracts instead of future contracts?
The notes state that if you are hedging an index or share with future contracts on the identical underlying (same term as well), then the hedge ratio is 1.
Surely this cannot be the case. Future contracts are margined daily which leads to the profits acrueing daily. This being the case, a future contract on the same underlying share is far more sensitive to movements in the share. The ideal hedge ratio surely would be the present value of 1, not 1.
The textbook Options, Futures, and Other Derivatives (6th edition, J. C. Hull), page 348 gives an explanation and a formula. The formula is that if H units of the underlying asset are required to hedge a position, then H*e^(-rT) future contracts would be required to hedge the same position. Hence in the case in ST5, if the underlying was a single share, then e^(-rT) futures would be the ideal minimum hedge ratio, not 1?
Do the notes mean to say forward contracts instead of future contracts?