PORTFOLIO HEDGING WITH FUTURES
Overview
Using short futures positions to offset potential losses in a long stock portfolio or commodity exposure. The hedge doesn't need to be perfect — even a partial hedge significantly reduces drawdown risk during market corrections.
Setup
- 1.Calculate portfolio beta vs. target index (S&P 500, NASDAQ-100).
- 2.Determine number of contracts: (Portfolio Value × Beta) / Futures Contract Value.
- 3.Short the appropriate index futures contract (ES for S&P-correlated, NQ for NASDAQ-heavy).
- 4.Monitor the hedge and adjust as portfolio value or market conditions change.
- 5.Define the hedge horizon (days, weeks, months) and expected cost.
Max profit
Hedge profit offsets portfolio losses — net result is reduced drawdown.
Max loss
If market rallies strongly, portfolio gains are partially offset by hedge losses (opportunity cost).
Breakeven
The hedge is cost-effective if market declines exceed the cost of maintaining the position (commissions + bid/ask spread).
When to use
Before major uncertainty events (FOMC, election, key economic data). During periods of elevated VIX (market fear). When you want to stay invested long-term but reduce short-term volatility.
When to avoid
When market direction is clearly upward and hedge would heavily drag performance. When transaction costs make partial hedges uneconomical.