Reviewed by Aug 27, 2020| Updated on
Futures equivalent refers to a quantity of futures contracts necessary to bring the risk profile of an options position in line with the underlying asset. A futures equivalent will apply only in the case of options which are having a futures contract as an underlying asset. Examples of futures contract include index futures, stock futures, currency futures or commodity futures.
Understanding Futures Equivalent
- Futures equivalent is helpful for a trader who wants to take a hedge against an options position. Futures equivalent will be quite useful when one wants to hedge exposure to an options position. Once a trader determines their futures equivalent, they can figure out the number of futures contracts they need to buy or sell to be able to hedge the options position and be neutral.
- A trader can calculate the futures equivalent by aggregating the delta of all their open options positions. It is necessary that the position in a futures contract should be equivalent to the risks in the option position. The aggregate delta is useful to go for a delta-based margining, hedging, and carry out risk analysis.
- Many stock exchanges use the delta-based margining system in options positions. The margining system aggregates the changes in the future contract prices or option premiums. Also, the futures contract prices are useful to determine the risk factors to determine the base margin requirements. A margin refers to the amount of collateral or money deposits a client needs to make with their brokers.
- Delta hedging can help to reduce or remove the risk exposure derived from an options position by taking the opposite positions in the underlying security. For example, in case a trader who enters into a gold futures contract and carries options position in the gold options equivalent to +20 deltas in terms of the futures equivalents, the trader can sell the 20 futures contracts to become delta neutral.
The common use of a futures equivalent is in delta hedging involving reduction or removal of the specific risk exposure as shown by the options position. Options do not constitute linear derivatives and their deltas can change with a change in the underlying futures contract. Consequently, the futures equivalents change with a change in the market prices.