Futures Equivalent

Futures Equivalent

Futures equivalent is the number of futures contracts required to match the risk profile of an options position on the same underlying asset. For example, if a trader has an options position in gold options that amounts to +30 deltas in terms of futures equivalents, they could sell 30 futures contracts in the market and become delta neutral. Being delta-neutral means that small changes in the direction of the market produce no profit or loss for the trader. Futures equivalent only applies to options where the underlying asset is a futures contract, such as options on stock index (S&P 500) futures, commodity futures, or currency futures. If a trader determines his futures equivalent, they can then buy or sell the appropriate number of futures contracts in the market in order to hedge their position and become delta neutral. As a result, the futures equivalents will change as the market moves, so if the gold market moves up by 1%, while the position may not have made or lost any money, the futures equivalent may have moved from zero for the hedged position to +5.

Futures equivalent refers to the amount of futures contracts needed to hedge an equivalent options position.

What Is Futures Equivalent?

Futures equivalent is the number of futures contracts required to match the risk profile of an options position on the same underlying asset. In other words, it is the amount of futures needed to offset the net deltas of an options position.

Futures equivalent refers to the amount of futures contracts needed to hedge an equivalent options position.
Futures equivalent only applies to options where the underlying asset is a futures contract, such as options on an equity index.
Futures equivalent is useful when one wants to hedge exposure to an options position or for computing the number of contracts needed to roll over an expiring position.

Understanding Futures Equivalent

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

Futures equivalent is very useful when one wants to hedge exposure to an options position. If a trader determines his futures equivalent, they can then buy or sell the appropriate number of futures contracts in the market in order 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 refer to the equivalent position in futures contracts that is needed to have a risk profile identical to the option. This delta is used in delta-based hedging, margining, and risk analysis systems.

Delta-based margining is an option margining system used 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 deposited by customers with their brokers.

Example of Futures Equivalents in Options Hedging

Most commonly, the futures equivalent is used in the practice of delta hedging. Delta hedging involves reducing or removing the directional risk exposure established by an options position by taking an opposite position in the underlying security.

For example, if a trader has an options position in gold options that amounts to +30 deltas in terms of futures equivalents, they could sell 30 futures contracts in the market and become delta neutral. Being delta-neutral means that small changes in the direction of the market produce no profit or loss for the trader. Here, if the price of gold increases by 1%, the options position will gain approximately 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. As a result, the futures equivalents will change as the market moves, so if the gold market moves up by 1%, while the position may not have made or lost any money, the futures equivalent may have moved from zero for the hedged position to +5. The trader would then need to sell five more futures contracts to return to delta-neutral. This process is called dynamic hedging, or delta-gamma hedging.

Related terms:

Commodity

A commodity is a basic good used in commerce that is interchangeable with other goods of the same type. read more

Currency

Currency is a generally accepted form of payment, including coins and paper notes, which is circulated within an economy and usually issued by a government. read more

Delta & Examples

Delta is the ratio comparing the change in the price of the underlying asset to the corresponding change in the price of a derivative. read more

Delta-Gamma Hedging

Delta-gamma hedging is an options strategy combining delta and gamma hedges to reduce the risk of changes in the underlying asset and in delta itself. read more

Delta Hedging

Delta hedging attempts is an options-based strategy that seeks to be directionally neutral. read more

Delta Neutral

Delta neutral is a portfolio strategy consisting of positions with offsetting positive and negative deltas so that the overall position of delta is zero. read more

Derivative

A derivative is a securitized contract whose value is dependent upon one or more underlying assets. Its price is determined by fluctuations in that asset. read more

Futures

Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and price. read more

Futures Contract

A futures contract is a standardized agreement to buy or sell the underlying commodity or other asset at a specific price at a future date. read more

Futures Exchange

A futures exchange is a central marketplace, physical or electronic, where futures contracts and options on futures contracts are traded.  read more