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Hedging


Learn how to diversify your risk through hedging strategies

ABC – Chart taken from POEMSView

Let’s assume Client A bought 1 lot of ABC (component stock) at the price of $15.43 on 15 April ’10, and soon after the price came tumbling down. What options does Client A have at this point? Assume bearish conditions.

  • Cutting losses

In normal cash trading, if the client held on to the position till 10 June ’10 and sold it off at $13.24,

Losses           = ($13.24 - $15.43) * 1,000
                 = $2,190

Commission       = ($15,430 * 0.28%) + ($13,240* 0.28%)
                 = $43.20 +$37.07
                 = $80.27 ($85.89 with GST)

Exchange fees    = $7.84 + $6.73
                 = $14.57

Nett Profit/Loss = ($2,284.84)
  • Wait for price to rebound higher than entry price to sell

How to potentially hedge away such risks using CFD?

Some investors may have a view that the trend will continue but is afraid of a reversal. In these cases the investor can choose to hedge and establish an opposite position in a counter which enjoys high correlation but smaller in contract value.

1. Hedge with Straits Times Index SGD5 CFD

To hedge his positions, Client A can choose to short sell 1 contract of Straits Times Index SGD5 CFD at 3,037 on 15 April ’10 and buy back at 2,750 on 10 June ’10.

Gross Profit/Loss = $287 * 5 = $1,435

Commission        = $20 ($21.40 with GST)

Interest          = $85.86

Nett Profit/Loss  = $1,329.14

Client A profits $1,329.14 from this hedging position, instead of losing $2,284.84. Overall, he would only lose a net loss of $955.70 from this hedge.

N.B.: Bear in mind that the contract value shorted for the Straits Times Index SGD5 CFD is larger than the ABC Long position and as such can be taken as a short-biased trade using original LONG ABC as a hedge. Straits Times Index SGD5 CFD would be a good hedge as this was a component stock.

2. Hedge with Equities CFD

Some clients have the view that once they are not in the market, its very hard for them to re-enter. As such, some clients still choose to hedge using the same counter.

Client A can short-sell ABC using Equities CFD at $15.43 and buy back at $13.24.

Commission       = ($15,430 * 0.148%) + ($13,240 * 0.148%)
                 = $42.44 ($45.42 with GST)

Interest         = $85.90

Nett Profit/Loss = $2,058.68

Client A profits $2,058.68 from this hedging position, instead of losing $2,284.84. Overall, he would only lose a net loss of $226.16 from this hedge.

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