If I am long 100 shares of SPY, what are some questions that I can ask myself to decide: Whether I should hedge by selling futures, or by buying put options?
What are some pros and cons of each?
Futures commit you to purchasing or selling a particular contract at some point in the future. The typical example is a grain farmer expects to grow a certain amount of grain over the coming year, so sells a grain future requiring delivery at the end of the year, locking in the price. If the market changes in the meantime, his future gives him protection against future price fluctuations. You could do this with a future on the S&P 500, but typical quantities of these futures are for much more than 100 contracts. This will prevent you from gaining any benefit from the appreciation of SPY during the period that the future is for, but will also prevent you from losing any money as well. Alternatively, you could sell your SPY position and re-open it at the end of the period.
A put option will give you the right to sell SPY at a given price, which is useful if the market goes down. If the market goes up, you don't have to exercise your option. However, options are sold at a premium, so you most likely will find that the cost of the option eats up any benefit it may have provided, but if it helps you sleep better at night knowing you can sell it at a particular price, then it may be worth it.
The S&P 500 futures are in contango and so there is an advantage to being sell-side on a long-term contract. The futures contract and the underlying investment will break each other even such that the investment gain will be the dividends on the SPY and the contango on the futures as moving towards the spot price.
However, a mini S&P 500 future is sized at about $136,000 and that's too big to hedge 100 shares of SPY. The minimum margin deposit on the mini S&P 500 future is $6000 but that doesn't allow for fluctuation.
Also, if an underlying investment is hedged with futures to avoid paying a capital gain tax, then IRS straddle rules may need to be followed.
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