This post will be dedicated to calculating your hedge using the S&P 500 emini futures.
First order of business is to know how many dollars you are up for the DAY. Let’s say for the sake of the example on Friday when the ES was hovering on support around 1106 you were up an arbitrary number of $3,400 alright so from the close on Thursday which was 1124.5 and the current ES price of 1106, is 18.5pts ES. $50 per point per contract so $925. So we take 3,400/925= 3.67 contracts. When we used to hedge we liked to round down, and it is more of a personal preference whether you would like to be slightly over or under hedged. So if you chose to round up and used 4 contracts in this example and decided due to how close we were to support, increasing delta, market internals etc that you wanted to protect your gains. You would buy 4 contracts at lets say 1106, and by the end of the day your hedge would have made 1119.5-1106=13.5, 13.5x50=675, 675x4=2,700. So instead of having 3,400 become $700 in gains, you have locked in your $3,400.
As a general rule of thumb in this example IF you decided to hold your hedge overnight due to fluctuating beta you would drop the 4th contract and be holding 3. You can always drop your hedge pre-market, overnight or during regular trading hours. So on one hand you are muting your gains but that is a small price to pay for protecting profits, lowering risk and peace of mind against gaps. When you hold overnight your hedge can be losing you money but generally when the market opens your other positions will make up the loss. But understand the risks of holding overnight!! Worst scenario would be you held too much overnight and got a margin call because of some news that happened while you were sleeping! So unless you know what you are doing don’t hold overnight.
The other beauty about this technique in hedging is that it allows you to practice day trading the futures for free. If the trade goes against you, your other positions should make up the loss. So if you are net short, then hedge by going long and taking every high probability signal to go long. Worst that can happen in that scenario is the market continues down and your other positions make up the loss. Although if for the flash crash for example some stocks did not react very strongly to it so being hedged on the ES could have hurt you. That however is an outlier event, that should be prepared for.
NOW for the other side of this sword, some people will hedge by chasing the market. That is a mistake because that will most likely lead to you losing on your hedge and locking in muted gains. IF you plan on using this technique I would recommend learning some day trading set-ups and studying the flow of the futures market, and if it resonates with you practice hedging in paper.
Anyways I hope this helps. I think David’s disclaimer also covers his guest posters but if not, you are responsible for your own actions.
