Question

3. After May 2020, what are the prospects of futures contracts as a significant risk management tool for firms? Discuss critically.

Answer 1

After May 2020, future contracts are generally exposed to a high level of volatility because there have been sharp surge in the volatility index which can easily visible and there have been a large number of participation increasing in the derivative markets from a large number of increasing new participants.

Prospect of future contract as a significant risk management tool I think is going to increase, because there will be a high amount of volatility existing into the market and people are going to take various hedging position and they will be trying to hedge their portfolios and they will be trying to take contra positions due to which they can save their Gaines and they will be able to help themselves in order to secure from any kind of Black swan event.

There is increased uncertainty in market due to coronavirus concern and the market is swinging like a pendulum in in past few weeks because people are not able to decide that how much damage it is going to do to the financial system so they are trying to discount that into the overall market and it has been reflected that there was a sharp cut into the share prices but share prices has recovered dramatically and it has recovered very sharply also so it can be said that due to increase in the volatility the importance of the future contracts will be increasing into the overall stock market because people will be generally tend to increased their position into the future contracts as they will be looked as a very good hedging opportunity.

One should be very clear about the applicability of future contract in risk management of portfolio as one can take opposite positions in order to save his portfolio like if I am long on a Portfolio of 10 stocks of Dow Jones, I will be trying to short DJIA future in order to help myself from any kind of downside and the possibility of sharp cut has increased due to expectation of an impending recession in the United States economy and these cuts can be protected through short contracts on the Dow Jones industrial Average or other indexes or other structures which will be helpful in order to secure the gains so after May 2020, the significance of future contracts is going to increase more.