Futures Equivalent

What Is Futures Equivalent?

Futures equivalent is the number of futures contracts required to match the risk profile of a options position on the equivalent underlying asset. All in all, it is the amount of futures expected to offset the net deltas of an options position.

Figuring out Futures Equivalent

Futures equivalent just applies to options where the underlying asset is a futures contract, for example, options on stock index (S&P 500) futures, commodity futures, or currency futures.

Futures equivalent is extremely valuable when you need to hedge exposure to an options position. On the off chance that a trader determines their futures equivalent, they can buy or sell the proper number of futures contracts in the market to hedge their position and become delta neutral. The futures equivalent can be calculated by taking the aggregate delta associated with an options position.

The term futures equivalent is generally used to allude to the equivalent position in futures contracts that is expected to have a risk profile indistinguishable from the option. This delta is utilized in delta-based hedging, margining, and risk analysis systems.

Delta-based margining is an option margining system utilized by certain exchanges. This system is equivalent to changes in option premiums or future contract prices. Futures contract prices are then used to determine risk factors on which to base margin requirements. A margin requirement is the amount of collateral or funds stored by customers with their brokers.

Illustration of Futures Equivalents in Options Hedging

Most ordinarily, the futures equivalent is utilized in the practice of delta hedging. Delta hedging includes diminishing or eliminating the directional risk exposure laid out by an options position by taking a contrary position in the underlying security.

Being delta neutral means that small changes toward the market produce no profit or loss for the trader.

Assuming that a trader has an options position in gold options that amounts to +30 deltas in terms of futures equivalents, for instance, they could sell 30 futures contracts in the market and become delta neutral. Here, assuming the price of gold increments by 1%, the options position will gain roughly 1%, while the short futures will lose 1% — netting out to zero.

Of course, options are not linear derivatives and their deltas will change as the underlying moves — this is known as the option's gamma. Accordingly, the futures equivalents will change as the market moves. Assuming the gold market climbs by 1%, for instance, while the position might not have made or lost any money, the futures equivalent might have moved from zero for the hedged position to +5. The trader would then have to sell five additional futures contracts to return to delta-neutral. This interaction is called dynamic hedging, or delta-gamma hedging.

Features

• Futures equivalent is helpful when one needs to hedge exposure to an options position or for computing the number of contracts expected to roll over a lapsing position.
• Futures equivalent alludes to the amount of futures contracts expected to hedge an equivalent options position.
• It just applies to options where the underlying asset is a futures contract, for example, options on an equity index.