What Are the Pros and Cons of Hedging with Derivatives?

Hedging, commonly known as "haiqin", also known as hedging trade, refers to the fact that when a trader buys (or sells) the actual goods, he sells (or buys) the same amount of futures on the futures exchange. The transaction contract serves as a hedge. It is an act to temporarily replace physical transactions with futures transactions in order to avoid or reduce the loss of adverse changes in prices. ^[1]

Hedging

The basic characteristics of hedging:

1. Principle of opposite direction of transactions;

According to the different directions of participating in futures trading, stock index futures hedging transactions can be divided into two types: buying hedging and selling hedging.

1.Hedging when buying

Stock index futures buying hedging refers to a trading method in which investors buy the corresponding stock index futures contract for hedging because they are worried about the price of the target index or stock combination rising, that is, first to establish a long trading position (position) in the futures market , Hedging transactions at the end of the hedging period, so it is also known as "long position". The purpose of buying hedging is to lock in the buying price of the target index fund or stock portfolio and avoid the risk of price rise. Investors mainly buy hedges under the following conditions:

1) Investors expect to receive a large amount of funds in the future and prepare to invest in the stock market. However, research shows that the stock market will gradually rise before the funds are in place. If the funds are in place to open a position, it will inevitably increase the cost of opening a position. At this time, the purchase of stock index futures contracts can hedge the risk of rising stock prices. Because stock index futures trading has a leverage mechanism, the amount of funds required to buy stock index futures contracts is small.

2) Institutional investors now have a large amount of funds and plan to buy a group of stocks at the current price. Due to the large amount of stocks to be purchased, completing a position in the short term will inevitably push up the stock price and increase the cost of opening positions. But worry about price increases. Buying stock index futures contracts at this time is the way to solve the problem. The specific operation method is to first buy the corresponding number of stock index futures contracts, and then buy the stocks step by step. When opening positions in batches, the corresponding stock index futures contracts are sold in batches and closed.

3) In the stock market that allows traders to short-sell the stocks, because the short-sale market has a definite return time, the short-sellers must buy back the short stocks in full before the scheduled date, and return the loan with a certain fee. By. When the stock-shorter shorts the stock, if the price is contrary to expectations and the price rises, the investor must buy the stock at a higher price in order to return the stock. At this time, buying the corresponding stock index futures contract can play a role in hedging the risk .

4) Investors sell call options on stock options or stock index options. Once the price rises, they will face large losses. At this time, investors can hedge the risks caused by buying corresponding stock index futures contracts to a certain extent.

2.Sell hedging

Hedging of stock index futures selling refers to a way for investors to sell the corresponding stock index futures contract because they are worried about the price of the target index or stock combination falling, that is, first open a position in the futures market and sell the stock index futures contract, pending decline The transaction behavior of buying and closing a position later is also called "short protection". The purpose of selling hedging is to lock in the selling price of the target index or stock portfolio and avoid the risk of falling prices. Investors generally sell hedges in the following situations:

1) Large institutional shareholders hold a large number of stocks and are planning to hold them for a long time, but they are short on the market. At this time, if you choose to sell on the stock market, due to the large number, it will put a lot of pressure on the stock price and cause higher shipping costs, and at the same time bear the corresponding transaction costs. At this time, the best option is to sell the corresponding stock index futures contract to hedge the risk of price decline in the short term.

2) Strategic investors who hold a large number of stocks are bearish on the market but are unwilling to lose their majority shareholder status by selling stocks. At this time, these stock holders can also hedge the price by selling the corresponding stock index futures contract. Downside risk.

3) Investment banks and stock underwriters sometimes need to use sell hedging strategies. For investment banks and underwriters, the ability to sell the underwritten stock at the expected price is largely related to the overall state of the stock market. If the overall situation of the stock market is not optimistic in the future, you can take the corresponding stock index futures contract to avoid losses caused by the decline in stock prices.

4) Investors sell put options on stock options or stock index options. Once the stock price falls, they will face a large risk of loss. At this time, the risk can be hedged to a certain extent by selling the corresponding stock index futures contract.

Soy Hedging Case (This example is only used to explain the principle of hedging. In specific operations, you should consider

In order to better achieve the purpose of hedging, companies are

Hedging can be substantially offset

With the development of international trade and investment, the disintegration of the Bretton Woods system, irreversible market globalization, and increased currency and commodity price volatility, the uncertainty of the real economy's operations has greatly increased. Managing the risk of price fluctuations is a problem that must be addressed by entrepreneurs across the country. ^[2]

Establishing a scientific and effective hedging management system is an important guarantee for the success of an enterprise's hedging. Management of hedging can be implemented from four aspects: organizational structure design, planning system, management and evaluation, and dynamic risk monitoring. The design of the hedging organization structure depends on four major factors: first, the characteristics of the industry, the concentration of risk-sensitive industries (such as commodities, finance) is better, and the limited concentration of industries with moderate risks (such as home appliances, daily chemicals) is better; The company's scale, the larger the scale, the more centralized control is needed; the third is the type of business, the larger the difference, the organizational structure should be dispersed, and the more homogeneous, it should be centralized; the fourth is the control basis, which requires experts and information reporting systems, and decentralized You need to strengthen the control system.

In addition, different performance assessment methods for enterprise hedging are also a headache for enterprises, especially state-owned enterprises. Wang Hongying, the dean of the Mid-term Research Institute, suggested that hedging performance be evaluated from the aspects of futures and spot, process and result. The process assessment is scored from three aspects: system compliance, procedure compliance, and execution efficiency. At the same time, corresponding weights are assigned to accumulate scores, and different levels of assessment scores are rewarded and punished accordingly. Results assessment should be treated differently depending on whether the objective of the enterprise assessment is hedging on a case-by-case basis or a comprehensive assessment.

Based on the practice and development of traditional hedging theory, a new theory has been formed, and some shortcomings of the original theory have been repaired and new breakthroughs have been made.

Fair value hedge accounting

When fair value hedging is used for hedging, gains or losses arising from changes in fair value are directly included in the current profit and loss; if the hedging instrument is a non-derivative instrument, the profits or losses formed are still included in the current profit or loss. The gain or loss formed by the hedged item is also included in the current profit and loss, and the book value of the hedged item is adjusted. For example, on January 1, 2010, the book cost of a product held by a manufacturing company was 50 million, and the fair value was 55 million. If it was sold immediately, it would make a profit of 5 million; the company is expected to sell on June 30, 2010. Considering the decline in fair value at that time, the company will lose the profit. In order to avoid the risk of changes in the fair value of the inventory products, the company decided to hedge this business. Because the inventory products already exist, fair value hedging is used for accounting treatment. In the futures market, choose to sell and inventory products in the quantity Derivative futures of the same or equivalent quality, assuming that the futures market is 52 million. On January 1, 2010, the fair value of the derivative product was zero because the futures price had not changed at this time. On June 30, 2010, Company A sold its inventory products at a fair sale price of 45 million, compared with the original fair value of 55 million, reducing revenue by 10 million. At the same time, Company A bought and closed futures contracts, assuming that it closed liquidation futures. The price is 42 million, compared with 52 million for opening a new futures price, and a gain of 10 million. Because Company A adopted a hedging strategy to avoid the risk of changes in the fair value of the inventory, the decline in its fair value did not adversely affect the original expected gross profit of 5 million. The hedging net profit or loss is zero. In this case, there is no "invalid hedging profit or loss", which is a fully effective hedging. Avoided the losses caused to enterprises by falling prices.

Cash flow hedge accounting

Foreign exchange risks and expected transactions caused by exchange rate fluctuations of enterprises can be used as cash flows for hedging. In the cash flow hedge accounting, the part of the hedging instrument gain or loss that is a valid hedging is directly recognized as owner's equity and reflected in a separate item; it is included in the owner's equity capital reserve account because it is mainly expected Transactions are not the same as fair value hedge accounting. Under normal circumstances, he only determines the changes caused by the hedging instrument. When the hedged item is disposed of, it is transferred to the current profit and loss. The gain or loss of the hedging instrument is invalid. The hedging portion is directly included in the current profit and loss. This can effectively control the behavior of some companies using hedge accounting to artificially manipulate profits, which fully reflects the principle of accounting caution.

Stock index futures hedging is the same as other futures hedging. The basic principle is to use similar trends between stock index futures and stocks to manage the position risk in the spot market by performing corresponding operations in the futures market.

Short hedge

Due to the arbitrage operation of stock index futures, the trend between the price of stock index futures and the stock spot (stock index) is basically the same. If the two steps are not consistent to a sufficient degree, it will cause arbitrage into this situation. He holds a basket of stocks in stock. He believes that the stock market may decline at that time, but if the stock is sold directly, his cost will be very high, so he can establish a short position in the stock index futures market, and when the stock market declines, Stock index futures can make a profit, which can make up for losses in stocks. This is called short-hedging.

Hedging

Another basic hedging strategy is the so-called long hedge. An investor expects to have a fund to invest in the stock market in a few months, but he feels that the stock market was very attractive at that time. If he waits for a few months, he may miss the opportunity to open a position, so he can start with stock index futures first. Establish a long position, and after the funds are available in the future, the stock market does rise and the cost of opening a position increases, but the profit from the closing of stock index futures can compensate for the increase in spot costs, so the investor locks the cost of the spot market through stock index futures .