HEDGING WITH FUTURES
Plain English
Hedging means using futures to protect against losses in an existing position. If you own stocks, you can short index futures to offset a market decline. If you're a farmer, you sell commodity futures to lock in a price. Hedging doesn't eliminate risk — it transfers it.
Going deeper
Hedging calculates the number of contracts needed to offset exposure. Beta-adjusted hedge for stocks: Contracts needed = (Portfolio Value × Portfolio Beta) / (Futures Contract Value). A $1M portfolio with beta 1.2 against S&P 500 at 5,000 ($250K/contract) needs 4-5 ES contracts to fully hedge. Commodity hedges for producers: a wheat farmer expected to produce 100,000 bushels sells 20 CBOT wheat contracts (5,000 bu each). For importers/exporters: currency futures hedge foreign exchange risk. Partial hedges (50% of exposure) reduce risk while maintaining some upside. Hedging costs include commissions, bid/ask spread, and basis risk (difference between futures price and spot price).
Examples
Stock Portfolio Hedge
You own $500,000 of tech stocks (beta = 1.5 vs S&P 500). Hedge ratio: $500,000 × 1.5 / $250,000 = 3 ES contracts. Short 3 ES. If market drops 10%, your stocks lose roughly $75,000 but your short ES position gains ~$75,000. Net: flat. You pay the cost (commissions + missed upside if market rallies).
Cross-Hedge
A US company will receive €10 million from European sales in 90 days. They short EUR/USD futures (80 contracts × 125,000 EUR = €10M). If EUR weakens 5% versus USD, the company receives fewer dollars — but the short futures gain offsets the currency loss.