A futures contract is an agreement between two parties for the sale and purchase of an asset at a specific price on a particular date in the future. This is often done in an attempt to offset investment risk, and may or may not be successful, depending on what the market actually does. Calculating the appropriate hedge helps to ensure that a person’s investment portfolio remains in balance and changes in the market do not necessarily damage the person’s financial worth.
1. Decide which market you will use for your calculations. The overall makeup of the market should be as similar as possible to your portfolio. The S&P 500 has holdings that cover a broad market index, NASDAQ 100 is composed of big tech stocks and the Dow Jones Industrial Average consists mostly of blue chip stocks. Choosing the right market will help your hedge calculations be more effective.
2. Research the current value of your portfolio. If you are not in the habit of checking on a regular basis, your broker will be able to give you this information. Unless you made investments very recently, don’t use the value at the time of purchase; be sure to use the current value.
3. Find the value of the fund on which you plan to base your hedges. These change constantly, but you can use the most current figures you can get for your calculations. For example, you might find that the NASDAQ 100 has a value of 2,238, the Dow Jones Industrial Average is at 11,650 and the S&P 500 has a current value of 1,219.
4. Use the appropriate multiplier for the fund you have selected, typically published by each fund on a regular basis. These are variable over time and are also different depending on whether you are working with a standard futures contract or an e-mini futures contract. Some examples of what you may find are NASDAQ 100 multipliers of 100 and 250 for standard contracts and 20 for e-mini contracts.
5. Multiply the current value of the hedge fund you have selected by the appropriate multiplier to determine which futures contract is best for you. For example, if you have determined that the NASDAQ 100 is the fund your portfolio is most closely related to, use those figures. You will multiply the current NASDAQ 100 value, 2,238, by the appropriate multiplier, which will be 100, 250 or 20. If you have a relatively small portfolio, you should use 20 to arrive at the value of $44,760 for an e-mini hedge fund. You can then either combine futures contracts to reach the value of your total investment portfolio or move to a standard contract, with a starting value of $223,800 or $559,500 for this example.
- If you can’t find the exact type of fund you need to hedge your portfolio, choose the one that is closest to what you have in your portfolio for best results.
- Only buy what you need to hedge the actual value of your portfolio, since over-buying can result in an overall loss.
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