28 Nov
Hedging With Stock Futures | CA Final SFM
What are Stock Futures?
Stock Futures are financial contracts where the underlying asset is an individual stock. Stock Future contract is an agreement to buy or sell a specified quantity of underlying equity share for a future date at a price agreed upon between the buyer and seller. The contracts have standardized specifications like market lot, expiry date, price quotation, lot size, etc.
In finance, a single-stock future (SSF) is a type of futures contract between two parties to exchange a specified number of stocks in a company for a price agreed today (the futures price or the strike price) with settlement occurring at a specified future date, the settlement date.
How are Stock Futures Priced?
The theoretical price of a future contract is sum of the current spot price and cost of carry. However, the actual price of futures contract very much depends upon the demand and supply of the underlying stock. Generally, the futures prices are higher than the spot prices of the underlying stocks.
How are Stock Futures Settled?
Presently, stock futures are settled in cash. The final settlement price is the closing price of the underlying stock.
How are Stock Futures used to Hedge the Risk of the Stock Held in Spot?
It is now September 10th 2016, and NJ Ltd.’s stock is trading for ` 150.00 per share. You own 100 shares of NJ Ltd. and believe that a short-term (three-month) decrease in price is likely. You decide to sell one November NJ Ltd.’s future, which is currently trading for ` 151.50. If the stock does decline in price, you will incur a loss on your stock position. This loss, however, will be offset by a profit from a decrease in the price of your short NJ Ltd.’s future. On the other hand, if the price of NJ Ltd.’s stock rises unexpectedly, any loss incurred from your short futures contract can be offset by the increasing value of your NJ Ltd.’s shares. Your risk on the upside will be primarily in the form of opportunity loss.
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