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NISM Certifications · NISM-Series-VIII: Equity Derivatives · Strategies using Equity Futures and Equity Options

An investor holds a diversified equity portfolio and expects the market to fall over the next month, but does not want to sell the shares. Which of the following is the most suitable use of index futures?

The investor should sell index futures. If the market falls, the gain on the short futures position offsets the fall in the value of the held portfolio, so the shares need not be sold. Buying futures would increase exposure to the market decline.

  1. ABuy index futures to hedge the portfolio
  2. BSell index futures to hedge the portfolioCorrect
  3. CBuy index call options with a far strike
  4. DHold the portfolio and take no derivative position

Explanation

Selling index futures creates a gain if the index falls, which offsets the loss on the portfolio. Buying index futures would add to market exposure and increase the loss in a falling market. Buying calls does not hedge a decline.

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