Cross hedging on Commodity Futures Market

Alex K Mathews, Research Head, Geojit

It is very interesting to state that the equity cash positions or leveraged positions like futures and options market positions can be cross hedged with commodity markets.
The equity and equity derivative markets in India will close at 3.30 pm. It was difficult for an investor to reduce his Deltas; or want to increase hedge positions after the closure of NSE at 3.30Pm. For example; an investor who holds two lots of Infosys stock futures on his portfolio decided to take a hedge position on Nifty on the back drop of a fall in Nasdaq, does not have an instrument to hedge after 3.30 pm till the next day morning 9.55 Am.
Now let us look the basic principle of hedging which is taking an opposite position on the same underlying or related equities or commodities. Equity long positions can be hedged with equity options like buying equity put options, buying Index put options, selling Nifty futures or selling equity futures of same stock or stocks having high correlation.
The commodity futures trading starts in India at 9.55 Am and will come to an end only at midnight. This facilitates hedging in commodity futures against the equity market positions. The latest study shows that Dow Jones and Crude futures are inversely correlated. Like Crude futures Dow Jones industrial average and Gold futures are also inversely correlated. Finally Gold and Crude futures are positively correlated.
The inverse correlation helps the investors to take hedge positions on both Gold and Crude. As we discussed earlier an investor who holds Infosys 2 lot long can take a long on Gold futures or Crude futures for hedging. As the correlation between Dow and Crude works out to be negative, this strategy will reduce the risk of an investor. If Dow falls buy 250 points, the next day the Indian market will open with an down side gap of 300 points (because the correlation between these two indices are positive), and the Infosys future will come down on the opening session, but on the commodity side the futures of Gold /Crude will open with a firm note and will fetch a good amount of profit to the investor.