Dr Nijumon K John, Christ University, Bangalore 12/27/2025

HEDGING USING
FUTURES
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

LONG HEDGE & SHORT HEDGE

• In the case of a long hedge, the hedger does not own the underlying asset, but he needs
to acquire it in the future.
• He can lock-in the price that he will be paying in the future by going long in futures
contracts.
• In effect, he is already naturally short on the underlying stock because he must buy it in
future and he offsets this naturally short position by taking a long position in futures.
• Similarly, short hedge involves sale of futures to offset potential loss from the falling price
of underlying.
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

EXAMPLE
Dr Nijumon K John, Christ University, Bangalore 12/27/2025
Dr Nijumon K John, Christ University, Bangalore 12/27/2025
Dr Nijumon K John, Christ University, Bangalore 12/27/2025
Dr Nijumon K John, Christ University, Bangalore 12/27/2025
Dr Nijumon K John, Christ University, Bangalore 12/27/2025
Dr Nijumon K John, Christ University, Bangalore 12/27/2025
Dr Nijumon K John, Christ University, Bangalore 12/27/2025
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

• An Indian exporter will receive USD 200,000 in 3 months from a foreign buyer. Current
USD/INR spot = ₹83.00, 3-month USD/INR futures = ₹83.50. Currency futures
contract size = USD 1,000.
You expect the rupee to strengthen (USD to fall) and want to lock INR proceeds.
Determine the no of Contracts to sell and outcome if spot = ₹80.00 and futures =
₹80.20 at settlement.
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

• You hold 10,000 shares of ABC Ltd. Current spot = ₹150, 1-month futures = ₹152.
Futures contract = 1,000 [Link] fear a near-term drop, so you short futures.
Determine the no of Contracts to sell; net outcome if spot ₹140 and futures ₹141 at
expiry.
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

CROSS HEDGE

• When futures contract on an asset is not available, market participants search for an
asset that is closely associated with their underlying asset and trades in the futures
market of that closely associated asset, for hedging purpose (i.e., to protect the value of
their spot market position).
• For example, United Bank stock derivatives are not available in the F&O segment as it
does not qualify the selection criteria of the exchange but it may have good correlation
with PNB derivatives or with derivatives on Banking sectoral indices such as Bank Nifty.
• Hence, investors holding United Bank stock may set up a cross hedge for their
underlying position using PNB derivatives or Bank Nifty derivatives
Dr Nijumon K John, Christ University, Bangalore 12/27/2025
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

EXAMPLE
Dr Nijumon K John, Christ University, Bangalore 12/27/2025
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

HEDGING A STOCK PORTFOLIO

Dr Nijumon K John, Christ University, Bangalore 12/27/2025

PORTFOLIO BETA
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

HEDGE VALUE

• Hedge Value = Portfolio Beta x Total portfolio investment

• In this case, Hedge value = 1.223*800000= 978400

• The hedge value suggests, to hedge a portfolio of Rs.800,000/- we need to short futures
worth Rs.978,400/-
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

NO OF LOTS REQUIRED TO HEDGE

• Nifty future price = 9025

• Lot size = 25
• So, Contract value per lot = 9025*25=225625
• No of lots of Nifty futures required to short = hedge value/contract value =
978400/225625=4.33

• This is slightly under hedged

Dr Nijumon K John, Christ University, Bangalore 12/27/2025

OUTCOMES OF HEDGING IF NIFTY GOES DOWN

BY 500 POINTS
• Nifty position
• New Nifty future price = 8525(500points down or 5.5% down)
• Profit or Loss = 4*25*500= 50000

• Portfolio Position
• Decline in the market = 5.5%
• Expected decline in the portfolio = 5.5%*1.233= 6.78%
• Loss from the portfolio = 6.78% *800000=54240
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

HEDGING AN EXPECTED CASH INFLOW

• A fund manager will receive ₹2.50 crore (₹25,000,000) in cash in 2 months and plans to
invest it in equities then. To avoid missing gains if the market rises before the cash is
invested, the manager plans to buy index futures now.
• Index futures price = 21,000, Lot size = 50
• Determine the no of contracts to buy for full hedge. Also, calculate the P&L if the index
rises 6% by settlement.
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

• An investor is short equities worth ₹1.80 crore an unintended position, and wants to
neutralize market risk by buying index futures. Portfolio beta = 1.1. Index futures =
20,800, multiplier = 50.
• Determine the no of Contracts to buy to hedge. What will be the outcome if the market
rises 7%?
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

• You hold the following equity positions and want to fully hedge market (index) risk by shorting index
futures.
• Stock A: Investment = ₹300,000, Beta = 1.20
• Stock B: Investment = ₹500,000, Beta = 0.80
• Stock C: Investment = ₹200,000, Beta = 1.50
• Index futures price = 18,500 points. Lot size = 50
• A)Calculate the portfolio beta.
B) Calculate the number of index futures contracts to sell to fully hedge the portfolio
• C) What will be the outcome if market goes up or come down by 300 points
 Dr Nijumon K John, Christ University, Bangalore 12/27/2025

OPTIMAL NUMBER OF CONTRACTS

The number of futures contracts required is

  NA
N =h 
QF
where
NA size of the position being hedged (units),
QF size of one futures contract (units),
N* Optimal number of futures contracts
 Dr Nijumon K John, Christ University, Bangalore 12/27/2025

HEDGING USING INDEX FUTURES

• To hedge the risk in a (long) portfolio the number of contracts that should be shorted is

Where,
P
P is the value of the portfolio, N =

 is its beta, and A
A is the value of the assets underlying one futures contract
 EXAMPLE
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

Value of S&P 500 is 1,000

Value of Portfolio is $5 million
Beta of portfolio is 1.5
Each index point is 250 P
N =


What position in futures contracts on the S&P 500 is necessary to hedge

the portfolio?  $5,000,000
N = 1.5  = 30
$1,000  250
Go short 30 contracts (each futures contract is on 250 times the index)
 Dr Nijumon K John, Christ University, Bangalore 12/27/2025

CHANGING BETA
• What position is necessary if the beta of the portfolio is 0.75?

$5,000,000
15 = 
250,000

15
 = = 0.75
20
 Dr Nijumon K John, Christ University, Bangalore 12/27/2025

CASE STUDY
• X has a equity portfolio of Rs.25,00,000 with beta of 1.6. It is anticipated that the market will be bearish
in the next 3 months. Nifty is a broader index in India and currently trading at 12,000 points. Each index
point is Rs.50.
• Suggest the hedging possibilities using Index.
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

BASIS AND BASIS RISK

• Basis = Cash price (S) – futures price (F). On the initiation day, basis (S0 – F0) is known.

• The basis on the day the hedge is lifted is unknown (a random variable) unless:
• The day the hedge is lifted is the contract’s delivery day
• The contract’s underlying asset, its quality and its location, are the same as the cash item being hedged.

• Otherwise, is a random variable, and the hedger faces “basis risk”.

• In a cross hedge, there is always basis risk

Dr Nijumon K John, Christ University, Bangalore 12/27/2025
BASIS EFFECT ON HEDGING
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

Spot vs
Concept Market Meaning Effect on Hedging
Futures
Future expected ↑
Negative basis; futures fall
Contango F₀ > S₀ or high cost of
toward spot
carry
Market expects
Positive basis; futures rise
Backwardation F₀ < S₀ future ↓ or high
toward spot
convenience yield
Change in Hedge
Higher when basis behaves
Basis Risk (Spot − effectiveness
unpredictably
Futures) uncertainty
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

A STRIP HEDGE VS. A STACKED HEDGE

• Suppose a firm faces a series of dates (or periods) on which it faces price risk. That is, it
has a year (or longer) of production. It can:
• Use a “strip” of futures contracts, each with a different delivery date.
• Use a stack hedge, in which the most nearby and liquid contract is used, and it is rolled
over to the next-to-nearest contract as time passes.
Dr Nijumon K John, Christ University, Bangalore 12/27/2025

EXAMPLE

• On March 1, an oil distributor agrees to deliver 10,000 barrels of crude oil in each of the next 8
quarters, at a fixed price. The firm faces the risk that crude oil prices will ___ (rise or fall?), and
therefore will enter into a ___ (long or short?) hedge.

• On March 1, the firm can:

• trade 10 contracts for delivery in each of the next 8 quarters (This process is known as a “strip hedge.”)
• trade 80 June contracts. Then, in May, offset the June contracts and trade 70 Sept contracts. Then, in
August, offset the Sept contracts and trade 60 Dec contracts, etc. (This process is known as a “stacked
hedge.”)
• (Note: The last trading day of the June crude oil futures contract is the last business day in May, etc.)