Using stock index futures to help protect your portfolio binary code decoder


As an investor, you know that diversification can help you reduce overall portfolio risk. Investing in a basket of stocks that is well diversified across industries, geographies, and market capitalizations can potentially improve overall returns and provide some cushion against market downdrafts.

However, diversification may not always provide meaningful protection. Some events pose "systemic risks" that can impact the entire market—a Federal Reserve monetary action or a significant geopolitical event, for instance. And as we learned during the depths of the financial crisis, many stocks can move in tandem during serious market swoons. So diversification, while certainly helpful, can’t be counted on to snuff out risk entirely.

Another way to help protect the value of your stock investments is to use stock index futures and options.

Here, we’ll take a look at what they are, when you might want to consider them and how to calculate the appropriate number of contracts for hedging.

Stock index futures track equity market benchmarks like the S&P 500® Index, the Nasdaq® 100 Index, and the Russell 2000® Index—widely recognized barometers of the U.S. stock market.

The Chicago Mercantile Exchange launched S&P 500 stock index futures in 1982 understanding the futures market. However, mainstream interest took off when individual investors began noticing a downsized, electronically-traded version of this product that debuted in 1998—the E-mini S&P 500 contract chf usd. Today, the S&P’s little brother trades more than two million contracts per day on average.

Companies and individuals trade stock index futures for different reasons, but the primary goal is to profit from—or protect against—changes in the price of the underlying indexes.

Let’s take a look at how holding an appropriate number of S&P 500, Nasdaq 100, or Russell 2000 index futures or options contracts can help protect your portfolio value from market risk.

Suppose you’re holding a well-diversified portfolio of stocks valued at approximately $1,000,000. You’re concerned about a possible market decline but don’t wish to sell your stocks just yet—perhaps due to tax reasons or to avoid missing out on dividend payments. Or maybe you believe in the long-term potential of the stocks in your portfolio, even in the face of a general market decline.

In this situation, selling index futures contracts might provide an approximate hedge. If the market declines, your short futures position may yield profits to offset the losses on your stock holdings. If the market rallies, the futures position may produce losses that would offset appreciation in your stock portfolio. The hedged position is generally stabilized in value until you remove the hedge.

Now, let’s suppose that the composition of your stock portfolio resembles the S&P 500. The contract value of the E-mini S&P 500 futures contract is $50 times the index price. Therefore, to determine the number of E-mini S&P 500 contracts needed to provide coverage roughly equal to the value of your stock portfolio, divide your portfolio value by $50 times the current index how does the commodity futures market work. This calculation provides an approximation that’s adequate for most individual investors.

Want to get more complex? More complete hedge coverage requires a calculation of your portfolio beta—a statistical comparison of the portfolio’s changing value to the changes in the relevant index value over time. A portfolio beta of 1.0 indicates that over time the portfolio value has moved in the same proportion as the index. A portfolio beta of .7 indicates that the portfolio value has moved only 70% as far, on average, for each index price change.

Let’s look at our example again. Suppose you compare your $1,000,000 portfolio statistically against the S&P 500 and calculate a portfolio beta of 1.2. To find the number of contracts for full coverage, divide your portfolio value by $50 times the current E-mini S&P 500 futures price, and then multiply by the portfolio beta, one type of hedge ratio.

Full coverage with futures would require the sale of 11 contracts exchange rate usd to chf. This would effectively neutralize the portfolio, so that you’d expect neither to gain nor lose materially on the overall stock/futures position. If you later decide to increase or decrease the size of your portfolio, recalculate the needed coverage and adjust your hedge accordingly.

A hedge doesn’t need to neutralize an entire portfolio—you might want to consider phasing in a futures or options hedge. You could immediately initiate, say, 50% of the number of contracts you would need for a complete hedge. If your concern about the direction of the market proves correct and prices begin to decline, you may choose to increase your coverage, perhaps to 75% of the portfolio value. When you feel that the market is poised for a recovery, remove the hedge by phasing it out in a similar manner, or by offsetting the entire position euro exchange rate to canadian dollar. You can constantly make adjustments in this fashion, depending on how your market outlook changes.

If you have experience with equity options, you’ll find options on stock index futures to be similar. All the same principles and fundamentals apply, though in the case of options on futures, the underlying is a futures contract, rather than an individual stock or a stock index.

In the earlier section on hedging with futures, we used an example of a $1,000,000 portfolio requiring the sale of roughly 11 E-mini S&P 500 futures contracts for protection against an adverse downward move. Another possible alternative is to hedge using options. By buying 11 put options, you could defend against a large decrease in the value of the portfolio, while still maintaining your profit potential (less the cost of the put purchase) if the market were to rise.

To set up this strategy, you would buy the number of puts dictated by the short futures hedge ratio calculation. The degree of coverage is determined by the choice of the strike price usd to aud forecast. Higher strike puts would be more expensive than lower strike price puts, but the protective feature of higher strike puts becomes effective much sooner. The hedger is therefore faced with the decision of how much protection to take on, and at what cost.

 Potential profit = Virtually unlimited profit potential on the puts you’ve purchased, which is designed to offset the falling value of your stock portfolio

The principal reason to sell (or write) call options is to earn the premium usa today news. The writer of an E-mini S&P 500 call option receives payment (the premium) from the buyer of the option in return for the obligation of taking a short position in the futures contract at the exercise price if the option is exercised. The call writer’s risk is unlimited, while the call buyer’s risk is limited—and the call writer’s profits are limited, while the call buyer’s profits are unlimited.

In periods of stable or declining markets, call writing can mean an attractive cash flow from a relatively small capital investment. The hope is that, at expiration, the settlement price of the futures contract will be at or below the exercise price of the option. The option will then expire worthless—and you keep the entire premium.

The premium also gives limited protection against a drop in the futures price. The risk is that the value of the stock portfolio might decline by more than the premium received, and the trader may experience a net loss. However, depending on the strike price of the sold calls, the underlying stocks may rise in value without incurring a loss on the call options.

Investors should also note that if the market rises above the strike prices of the short calls, you may miss out on a market rally, as gains on the stock portfolio may be largely or entirely offset by losses on the short call position.

 Potential profit = If, at expiration, the underlying S&P 500 futures contract is quoted at 1870 or lower, the calls will expire worthless, and you’ll retain the entire premium amount of $6,050

Stock index futures and options offer investors numerous investing and trading opportunities—and in a declining or volatile stock market, they may be used as a hedging vehicle to help protect the value of your stock portfolio.

Like any other investment, the ultimate decision of whether or how to incorporate stock index futures into your portfolio should be based upon your personal goals and risk tolerance. But it’s important to know that futures and options strategies like those described in this article are available to individual investors.

I hope this enhanced your understanding of futures trading. I welcome your feedback—clicking on the thumbs up or thumbs down icons at the bottom of the page will allow you to contribute your thoughts.

Charles Schwab & Co., Inc. (“Schwab”) is registered as an Introducing Broker with the Commodity Futures Trading Commission, and is also a member of the National Futures Association (ID 277178) usd eur exchange rate history. Schwab does not make futures and futures options trading available to customers in Schwab accounts. Schwab customers interested in trading futures are referred to optionsXpress, Inc. (“optionsXpress”). Schwab and optionsXpress are separate but affiliated companies and subsidiaries of The Charles Schwab Corporation.

Trading futures involves substantial risk of loss and is not suitable for all investors. Past performance is not indicative of future trading results. Commentary and analysis is based on information taken from trade and statistical services, news services, and other sources which the author believes are reliable. Neither Schwab nor the author guarantee that such information is accurate or complete, and it should not be relied upon as such stock market terms and meanings. Commentary and analysis reflects our good faith judgment at a specific time and is subject to change without notice. All trading decisions in futures and futures options contracts will be made on a strictly unsolicited basis by the account holder.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Commissions, taxes and transaction costs have not been included in the examples used in this discussion, but can affect final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.

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