Thursday, September 06, 2007

Futures and Hedge

For eg

If you buy 100 Infosys Oct'07 futures for say Rs 1900 and you expect go to 2,000 - you will make a profit of ( 100*100) = 10,000.

However - u will lose a HUGE amount if Infosys tanks to Rs 1600 ( 100*300= 30,000) .

You can hedge yourself by buying a PUT option of infosys at say 1950 at Rs 30 at the cost of Rs 3000 .

The profit that you make when Infosys touches 2000 will be (10,000 - 3000).=7000

However - if the Infosys tanks to Rs 1600 - then your Put Option will be worth ( (1950-1600)*100 less premium paid 3000 ) = 32000 profit,while u wud have limited your futures 30000 loss with a risk free profit of 2000

Same can be done by selling a stock futures ( = Short Futures) and then buying a CALL option to hedge against price of shares going up.

If stock tanks - you make a lot of money, since u already sold futures at high rate.

Avoid buying or selling futures without a hedge,as it can/will lead to bankruptcy.
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