Stock Index Hedging

Trading of futures carries substantial risk of loss which is not limited to the value of your account. Past performance, whether real or hypothetical is no guarantee of future results.

This is an example of the first and best use of the futures market, namely hedging. Futures markets have been around for a very long time and nowadays, there is a futures market for nearly everything; agricultural (grains and meats), energy, metals, currency, stock indexes, and even single stocks. If you happen to own any of these things or want to own them, then having a hedging strategy can make owning them less risky and more profitable. A lot of people own stocks. If you do, then you may want to consider pairing it with a futures trading strategy to give more consistent returns. If you've owned stocks for the past ten years, you probably haven't done very well. Typically the market indexes outperform what most fund managers do and certainly they outperform what most small investors are able to do if they actively manage their stock portfolio. Congratulations if you're outperforming, but if you're not, then you may want to look at pairing your stock ownership with a futures trading strategy that can give better results.

The above chart is an example of what can happen. In the first case (the blue line) you see what happens if you bought the S&P index beginning in 2000 and simply held it until now. Not only has it not made a return, but inflation has taken a big bite out of the value of what's left. Instead of putting the entire $100k into the stock index, you could have taken half of it and put it into a futures account and actively traded it. For this example, I've used the SIF ES Swing system. It's traded about 85 times in the ten year period, so trading costs are minimal. Now, instead of losing 10% of your base capital your initial investment has more than doubled, and you still had half of your investment in stocks. Inflation is still taking its toll, and unless your futures account is tax deferred you will have to pay taxes on the earnings from the futures trading. Even so, you are much better off, and the worst equity decline was only about 15% of initial capital. If you're going to own stocks for very long, you'd better be prepared for much worse drawdowns than that. Since the stock market has done nothing for ten years, you may be thinking it's overdue for a move. Better take a look around the world. If you think the world economy is about the catch fire, then you are seeing a different picture than most of us and good luck with your buy and hold strategy. It's probably still ok, but you might be able to do better. Think about it.