38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
654 Part V: Index Options and Futures
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stock ownership. Moreover, he is able to establish that hedge at a much smaller com
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mission cost and with much less work than would be required to sell thousands of
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shares of stock. Similar thinking applies to all the cash markets that underlie futures
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contracts. The ability to hedge is important for people who must deal in the "cash"
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market, because it gives them price protection as well as allowing them to be more
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efficient in their pricing and profitability. A general example may be useful to demon
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strate the hedging concept.
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Example: An international businessman based in the United States obtains a large
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contract to supply a Swiss manufacturer. The manufacturer wishes to pay in Swiss
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francs, but the payment is not due until the goods are delivered six months from now.
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The U.S. businessman is obviously delighted to have the contract, but perhaps is not
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so delighted to have the contract paid in francs six months from now. If the U.S. dol
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lar becomes stronger relative to the Swiss franc, the U.S. businessman will be receiv
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ing Swiss francs which will be worth fewer dollars for his contract than he originally
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thought he would. In fact, if he is working on a narrow profit margin, he might even
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suffer a loss if the Swiss franc becomes too weak with respect to the dollar.
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A futures contract on the Swiss franc may be appropriate for the U.S. business
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man. He is "long" Swiss francs via his contract (that is, he will get francs in six months,
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so he is exposed to their fluctuations during that time). He might sell short a Swiss
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franc futures contract that expires in six months in order to lock in his current profit
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margin. Once he sells the future, he locks in a profit no matter what happens.
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The future's profit and loss are measured in dollars since it trades on a U.S.
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exchange. If the Swiss franc becomes stronger over the six-month period, he will lose
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money on the futures sale, but will receive more dollars for the sale of his products.
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Conversely, if the franc becomes weak, he will receive fewer dollars from the Swiss
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businessman, but his futures contract sale will show a profit. 111 either case, the
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futures contract enables him to lock in a future price (hence the name "futures") that
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is profitable to him at today's level.
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The reader should note that there are certain specific factors that the hedger
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must take into consideration. Recall that the hedger of stocks faces possible problems
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when he sells futures to hedge his stock portfolio. First, there is the problem of sell
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ing futures below their fair value; changes in interest rates or dividend payouts can
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affect the hedge as well. The U.S. businessman who is attempting to hedge his Swiss
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francs may face similar problems. Certain items such as short-term interest rates,
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which affect the cost of carry, and other factors may cause the Swiss franc futures to
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trade at a premium or discount to the cash price. That is, there is not necessarily a
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complete one-to-one relationship between the futures price and the cash price. |