Definition of futures equivalents


What is the futures equivalent?

The futures equivalent is the number of futures contracts required to match the risk profile of an option position on the same underlying asset.

Key takeaways

  • Futures equivalent refers to the number of futures contracts required to hedge an equivalent option position.
  • The futures equivalent only applies to options where the underlying asset is a futures contract, such as options on a stock index.
  • The futures equivalent is useful when you want to hedge your exposure to an options position or to calculate the number of contracts required to roll over an expiring position.

Understanding the futures equivalent

The futures equivalent only applies to options where the underlying asset is a futures contract, such as options on stock index futures (S&P 500), commodity futures, or currency futures.

The futures equivalent is very useful when you want to hedge your exposure to an options position. If a trader determines his futures equivalent, then he can buy or sell the appropriate number of futures contracts in the market to hedge his position and become delta neutral. The futures equivalent can be calculated by taking the aggregate delta associated with an option position.

The term futures equivalent is generally used to refer to the equivalent position in futures contracts that is needed to have a risk profile identical to that of the option. This delta is used in delta-based hedging, margin and risk analysis systems.

Delta-based margin is an option margin system used by certain exchanges. This system is equivalent to changes in option premiums or futures contract prices. The prices of the futures contracts are then used to determine the risk factors on which to base margin requirements. A margin requirement is the amount of collateral or funds deposited by clients with their brokers.

Example of futures equivalents in option hedging

Most commonly, the futures equivalent is used in the practice of delta hedging. Delta hedging involves reducing or eliminating the directional risk exposure established by an options position by taking an opposite position on the underlying security.

For example, if a trader has a gold option position that amounts to +30 deltas in terms of futures equivalents, he could sell 30 futures contracts on the market and become delta neutral. Being delta neutral means that small changes in market direction do not produce profit or loss for the trader. Here, if the price of gold increases by 1%, the option position will gain approximately 1%, while the short futures will lose 1%, reaching zero.

Of course, options are not linear derivatives and their deltas will change as the underlying moves; This is known as the range of options. As a result, the futures equivalents will change as the market moves, so if the gold market rises 1%, while the position may not have made or lost money, the futures equivalent may have passed zero. for the covered position to +5. The trader would have to sell five more futures contracts to return to the neutral delta. This process is called dynamic coverage or delta-gamma coverage.

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Mark Holland

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