Question

Assume you have been given $400,000 CAD with access to all listed stocks, bonds, futures, and options worldwide. You can trade in options and futures, in combination with the underlying asset. Assume today is Feb 1, 2020 and you have been given $400,000 CAD fake money to trade until April 20, 2020.

Perform a hedging trade; identify and invest in an underlying asset in the market and carry out the hedge with futures contracts (hedging strategy)

Describe the trade and provide the reason for such trade.

Please provide table and or/ graph.

Answer 1

Solution:

Part A )

We can invest in the equity stock and we are buying 1000 stocks of company A at CAD 100.

We are purchasing the stock hence we will sell the future contract with 1000 lot size to hedge the downside risk. Suppose future is selling at CAD 105 then we will sell it.

Part B ) Trade includes purchasing the equity stock and selling the future to hedge the risk. We think that the share price of the stock might fall and we could make loss hence when we sell the future at 105 then even when the spot price goes below purchase price then we will make money as we have sold the future at 105.

Part C )

When we hedge the position then our profit will be fixed at 5 per share irrespective of the spot price.