I am actually short on futures so can you tell me how I can hedge my risk and whether it is possible at all?
Answer
Answer
That answer is, “Yes you can”. Since traders are not permitted to short sell in the cash market for more than a day; one way is to sell futures. Suppose you sell Reliance Industries futures at Rs.980. You will make a profit if the price goes down. But what if the price goes up? You can hedge your short futures by buying a call option. Assume that you buy an Rs.990 Call option on RIL at Rs.10; then what is the protection that you get?
Short Futures
Amount
Call Option
Amount
Futures of RIL sold at
Rs.980
If price of RIL goes to
Rs.1050
If price goes up to
Rs.1,050
Profit on Call Option
Rs.60
Loss on short futures
Rs.70
Option Premium Paid
Rs.10
Hedge by buying
990 Call @ Rs.10
Net Profit on Call
Rs.50
Max Loss on position = Rs.(-20)
Max Profit – Unlimited on the downside
That is how options can be used to hedge (protect) your risk in a very simple way! You surely now agree that there is not much of rocket science to hedging with options!