Chapter VIII Hedging and Arbitrage of Futures Chapter VIII Section 2 Hedging and Arbitrage of Futures

I. Futures hedging

(I) Basic concepts and principles of hedging. Hedging can also be called "hedging".

Hedging is a kind of futures trading behavior aimed at avoiding spot risk. It means that the operators or traders related to the spot market buy or sell a certain number of spot varieties in the spot market, and at the same time sell or buy futures contracts with the same spot varieties, the same value but the opposite direction in the futures market, so as to make up for the losses in another market at the same time in the future, thus avoiding price risks.

Hedging can avoid price risk, because the futures market has the following economic principles:

1. The futures price trend of the same variety is consistent with the spot price trend.

2. As the expiration date of futures contracts approaches, spot prices and futures prices tend to be consistent.

(2) Hedging direction

1. Buy a hedge. Buying hedging, also known as "long hedging", refers to spot traders buying futures in the futures market for fear of rising prices, with the aim of locking in the buyer's price and avoiding the risk of rising prices.

2. sell the hedge. Selling hedging, also known as "short hedging", refers to spot traders selling futures in the futures market for fear of falling prices, with the aim of locking in the selling price and avoiding the risk of falling prices.

(C) The impact of basis on hedging effect

The effect of hedging depends on the change of basis. Basis refers to the difference between the spot price of the same commodity in a specific place and the futures contract price at the same time.

If the basis difference is not equal at the end of the hedging, the hedging will have a certain loss or profit.

When the basis becomes smaller, hedging can make money. The reduction of basis is often called "basis weakening". Therefore, a weak basis is conducive to buying hedgers. It can also be proved that when the basis becomes larger, that is, the basis becomes stronger, which is beneficial to selling the hedger.

(4) Hedging trading of stock index futures.

1. Hedging opportunity

Whether or not to hedge and when to hedge are essentially related to investors' judgment on the risk of the market outlook. Usually, we don't lock all the risks in one price, but prefer to adopt a dynamic hedging strategy.

2. The choice of circumvention tools

Generally speaking, the index futures highly related to stock assets should be selected as the hedging object.

3. Determination of the number of futures contracts

Hedging ratio refers to the ratio relationship between the total value of futures contracts determined by hedgers when establishing trading positions and the total value of insured spot contracts, so as to achieve ideal hedging effect.

The first method is to directly take the hedging ratio as 1.

The second method is designed for the hedging of stock index futures.

Number of contracts = total spot value/unit futures contract value ×β If the β value of a spot portfolio is greater, the number of contracts to be hedged will be greater. This is very reasonable, because the greater the β value, the greater the system risk, and the futures contract needs to have enough market value to hedge.

(5) Hedging principle

Generally speaking, hedging operations should follow the following basic principles:

1. Correspondence principle of buying and selling directions. Typical hedging should be to establish positions in opposite directions in the spot and futures markets at the same time or in a similar time, and reverse the original positions in the two markets at the end of hedging.

2. The same variety principle. In principle, the futures varieties selected for hedging should be consistent with the spot varieties, because only the varieties are consistent can the futures and spot prices tend to be roughly consistent in trend.

3. The principle of equivalence.

4. The principle of the same or similar month. As far as the same commodity is concerned, there are usually several futures contracts delivered in different months that can be traded on one exchange.

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