An investor owns one thousand shares of Reliance. Around budget time, he gets uncomfortable with the price movements. One contract on Reliance is equivalent to 100 shares. Which of the following will give him the hedge he desires? Buy 5 Reliance future contracts Sell 10 Reliance future contracts Sell 5 Reliance future contracts Buy 10 Reliance future contracts
Question
An investor owns one thousand shares of Reliance. Around budget time, he gets uncomfortable with the price movements. One contract on Reliance is equivalent to 100 shares. Which of the following will give him the hedge he desires? Buy 5 Reliance future contracts Sell 10 Reliance future contracts Sell 5 Reliance future contracts Buy 10 Reliance future contracts
Solution
The investor owns 1000 shares of Reliance. If one contract on Reliance is equivalent to 100 shares, then 1000 shares would be equivalent to 10 contracts.
If the investor is uncomfortable with the price movements and wants to hedge his position, he would want to take an opposite position in the futures market to offset potential losses in the spot market (where he currently holds the shares).
If he is worried about the price of Reliance shares falling, he would want to sell futures contracts. This is because if the price of the shares falls, he would make a gain on the futures contracts (as he would be able to buy at a lower price in the future than the price at which he sold the contracts) which would offset the loss on the shares he holds.
Therefore, to hedge his position, the investor should sell 10 Reliance future contracts.
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