The stock market is off to one of its more volatile years in recent history, and it’s showing little sign of stabilizing. At the halfway point of 2020, the Small Stocks 75 Index has already posted a high-to-low range exceeding the ranges of each of the last four years, and it has shown 13 daily moves exceeding 5% in either direction and 23% more unique price levels than the average full year of trading going back to 2016.
Yet stocks are, for the most part, back to unchanged on the year, and Small Stocks 75 in particular is only a few percentage points away from where it started in 2020. This environment can create frustration for passive investors witnessing heightened volatility with little, if any, growth in investment.
Passive market participants might feel paralyzed by long stock portfolios set to profit in the long term that are susceptible to daily volatility in the short term. Those seeking returns from owning stocks for multiple years can reduce exposure without uprooting investment in times of fear by using capital-efficient futures products.
How to Hedge Stocks with Futures
Selling small, cost-effective futures at reduced rates relative to stocks can hedge long stock portfolios with more flexibility than large, traditional futures. The number of contracts to commit to the hedge depends on the trader’s stock portfolio value, the percentage of the portfolio they wish to hedge, and some simple futures math:
Number of Contracts = [ Portfolio Value X Hedge Percentage ] / [ Futures Price X Multiplier ]
While traditional stock futures have varying multipliers ranging from quarters to hundreds of dollars, all Small Exchange futures observe the same $100 multiplier.
2020’s Second Half Outlook
There’s no telling how volatile the second half of the year will be or where the stock market will conclude in 2020, but the long-term investor will most likely encounter short-term rallies and declines similar to the last six months. Having the ability to actively manage risk could prove useful if the uneasiness in equities continues.