Question

You need to hedge the risk in a stock portfolio that your company owns in it's pension plan using the E-mini S&P500 futures contracts (that has a multiplier of 50). The current value of the portfolio is $325 million and the S&P500 is currently at 2637.72 while the futures price for the next month delivery is at 2643.25. You estimate that the beta of this portfolio is 1.1 while the beta of the S&P500 is 1. What position do you take in futures. You need to round to the nearest contract.

How would you change your answer if you decided to tail the hedge?

Answer 1

We are holding the stock portfolio in the pension plan. Hence to hedge the rish we will have to short the E Mini S&P 500 futures contracts. The beta of the portfolio is 1.10.

So the number of contracts required to hedge the portfolio is ($325 million * 1.10) / ($2643.25 * 50) = 2,705 lots.

Hence, here we will short 2,705 lots of E Mini S&P 500 futures contract.

If we decide to tail the hedge we will take less contracts of E Mini S&P 500 to hedge our portfolio and will gradually increase the number of lots as the time to lift the hedge comes nearer.

The number of lots which we will short to hedge our portfolio will be 2705/(1 + rd/365)

where, d = number of days until the hedge is anticipated to be lifted

r = the annualized interest rate.