These days for Retail Traders trading in futures trading requires a huge margin. Approximately 1.65 Lakh per lot is required for carrying forward future trades. However with the New Margin regulations with Hedged Futures, one can bring down the Margin Requirement drastically as low as Rs25,000 – 70,000 per lot depends upon the selection of Option Strike Price.
What is a Hedged Futures?
We know that trading futures involve unlimited reward and unlimited risk. However by adding out of the money option one can convert unlimited risk to limited risk and exchange also provides more margin benefit since the risk for the trader is controlled.
For Long Futures – OTM Put Option is used as a hedge
For Short Futures – OTM Call Option is used as a hedge
Hedging with Deep OTM Call Option
Will it Affect Profitability?
Remember Hedging comes at a cost. And If you are buying 10 strike wide option. You are most likely to buy cheaper OTM calls and hence tiny amount of your profitability is likely to be impacted.
Hedging with Near ATM Call Option
However if in case you are selecting near ATM strikes and more premium has to be paid in that case Margin comes down drastically as shown above however more the margin comes down more it impacts the profitability.
Which Strike Price to Select
If you are looking for a reasonable reduction in Margin then consider deep OTM Options with 8 strikes or 10 strike wide from ATM Options that brings a net portfolio Delta maintained well above 0.75-0.85 levels which compensate tiny to moderate effect on profitability compared to naked futures trading.
If you are looking for a drastic reduction in margin then consider ATM Options with 1-2 strike wide from ATM Options that brings net portfolio anywhere between 0.5 – 0.65 levels which compensates the profitability to a greater extent compared to naked futures trading.
Which Hedges to Consider Weekly or Monthly?
Of course Weekly OTM Strikes are cheaper and there is no significant change is premium irrespective of whether you are selection weekly option as hedge or monthly option as a hedge.
Weekly Option always act as cheaper hedges compared to monthly options. However point to be noted that Weekly Options erodes faster in time compared to monthly options because of the theta decay factor.
Tips for Small Account Holder
If you are a small account holder always Buy your hedge first followed by the directional futures position. This way margin will be effectively reduced for the small account holders.
This way you can bring down the cost of your margin requirements in your directional trades and thereby reducing the drastic risk if any due to unforseen events in the markets.
In the next tutorial I will be explaining how to automate your Buy or Sell Signal trades with Hedged Futures to carry forward your positional systematic trading strategies. Stay Tuned!