Basic example of hedging with futures

Long a futures contract, then long another futures contract with the opposite results to hedge it.

Ex:
Suppose you have a contract and the price of the futures contract increases by $10,000 when the price goes up by 1 cent. And decrease by $10,000 when the value goes down...

According to this example.. You can Hedge this risk by getting another futures contract that increases by $10,000 when the price goes down by 1 cent. And decrease by $10,000 when the value goes up...

Ok.. How exactly does this work!? They are not related in anyway or a least to what I've read... This makes no sense it's like buying a share of Google then yahoo... Yahoo doesn't hedge anything! What if both of them go in opposite directions?? Then you'll lose money 2x or win money 2x.. But more importantly, isn't that the same as investing in 2 different securities?

Somebody please explain... I don't know how this Naturalizes the risk in any way and this is suppose to be a very basic example in a perfect world....

A stock is $30/share today. You buy 100 shares for $3000. Next year $25 put option is $0.05. You buy one contract for $50.

In 6 months, if stock is $35/share, your assets are worth $3500, and options are worthless.
If stock tanks to $20, your holdings are worth $2000 and your option contract is worth $500, for a total of $2500.

Thus, you only lost $500 and not $1000 by hedging $50 worth of options.

This is a somewhat academic/idealistic example as there are other variables in play.

Make beta equal zero

Murrowboy said:Ok.. How exactly does this work!?
Balancing Assets to try and make a gain in any scenario, its not easy but here is an example.

If current value:
Stock A = 70
Stock B = 60
Stock C = 80

If expected value in bear market:
Stock A = 50
Stock B = 30
Stock C = 38

Expected Bull:
Stock A = 100
Stock B = 120
Stock C = 112

If you buy A + B and short C in any scenario you will make a profit. Do the math if you want.

I think what you want to research is the Arbitrage Pricing Theory

Umm, if you believe markets are efficient then there are no arbitrage opportunities since they are immediately executed.

Buying google and yahoo does not hedge anything,... a very basic hedge concept... buying exxonmobile to hedge increasing gas prices at your local gas station

when you buy futures, you generally get long exposure to the underlying. so if you bought a futures contract on something (say the S&P 500), then you would need to short another contract (say the Russell 2000) to hedge some of the long market exposure.

If two assets are negatively correlated, then you could buy one futures contract of each to reduce the risk of the overall portfolio, but I wouldn't call that a hedge.

Murrow, you DEFINITELY should stay away from trading until you have a better grasp of the futures' market.

If you're long a commodity and then decide to short the same contract,then your trade is terminated. You CAN buy/sell options on futures in the same way that you can on stocks. For example, if you own a long S&P contract, you can purchase a put option under the market for protection.

Good Luck,