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1982issue C061-2

Basis-managed hedges and related market substitutes

A cash or inventory book can be paired with an opposite futures overlay, then placed, lifted, or switched as the basis and related-market substitutes change. Editorial: test the listed future as a proxy first, then let the cash-futures gap and the price-spectrum decide the route.

  • A cash or inventory book can be paired with an exactly opposite futures position so large outright price swings are offset rather than absorbed.
  • The basis, and whether the market is a carrying-charge-market or an inverted-market, decides when a buying-hedge or a selling-hedge is said to benefit.
  • When the matching future is missing, thin, or started at an unfavorable basis, the procedure substitutes a cross-hedge in a related commodity or spread.
  • Place and lift timing is monitored with a Markov transition model and is also described with linear programming, decision trees, and moving averages.
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Basis trading1 readingCross hedging1 readingCurrent trackHedging strategy25 readings

Place, lift, or switch the overlay

A cash or inventory book can be paired with an exactly opposite futures position so that large outright price swings are offset rather than absorbed.

An alternative overlay places and lifts futures on only part of inventory more than once in order to trade changes in the futures-minus-spot gap. That gap is the basis.

Editorial: treat the hedge as a place, lift, or switch procedure. Keep the overlay only while the listed future remains the right proxy and the basis supports it.

Read the basis before keeping the match

When carrying costs dominate, futures are described as trading above cash. That state is a carrying-charge-market. When shortage fears dominate, futures are described as trading below cash. That state is an inverted-market. Near expiration the two prices are described as nearly equal.

A long-futures, short-cash pairing is labeled a buying-hedge and is said to benefit when the basis widens in a carrying-charge-market or narrows in an inverted-market. The opposite pairing is labeled a selling-hedge and is said to benefit in the reverse basis cases.

When no matching future exists, the listed market is thin, or the starting basis is unfavorable, the procedure substitutes a related commodity or a spread. That substitute is a cross-hedge.

Worked substitutions include industrial or precious-metal futures for strategic metals that lack their own contracts, Treasury-bond futures for a diversified equity book when the stock-index future is treated as thin, and silver spreads for a rate-sensitive book when the bond-future basis is unfavorable.

Route metals on the price-spectrum

A metals overlay is described as depending on rates, related-metal prices and spreads, and the gold-silver-ratio. Those related prices and spreads are the price-spectrum of the book being hedged. The gold-silver-ratio is gold price divided by silver price and is said to oscillate between 30 and 60. Near 60 a gold inventory seeking a buying-hedge is routed into silver, and at 40 the two metals futures are treated as interchangeable.

A gold-versus-platinum price gap is said to range from a 15-dollar platinum premium to a 65-dollar gold premium, and a 60-dollar gold premium is treated as a reason to place most of the hedge in platinum despite thinner platinum futures.

Time the overlay and treat the roles as overlapping

Placement and lift timing is monitored with a Markov transition model and is also described as using linear programming, decision trees, and moving averages.

Hedgers and speculators are treated as overlapping roles because a buying-hedge can transfer residual risk to a selling-hedge. That overlap is used to question speculative position limits and extra speculative fees versus margins by customer risk class and commissions by trade volume.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
1 of 23 in the Hedging strategy track
19901-2 pp.Next on Hedging strategyOptions as insurance unless the process is completeThe archive told owners of a part-time book that consistency from pure speculation was effectively unavailable to them.
All readings on this track · 23 readings
  1. 1982Basis-managed hedges and related market substitutes
  2. 1990Options as insurance unless the process is complete
  3. 1996A price-weighted technology index as a hedge and sector proxy
  4. 2002Single-stock futures as a month, margin, and hedge overlay
  5. 2004Listed volatility futures as a portfolio volatility hedge
  6. 2006Customized commodity hedges for bond and equity portfolios
  7. 2007Use of capital for overnight pairs and hedge layers
  8. 2007Opening auctions, limit envelopes, and overnight hedges
  9. 2008A two-gate intermarket test for equity bear hedges
  10. 2010Gold futures after a large setback: cluster risk and hedge timing
  11. 2011Partial commodity hedges, seasonal timing, and option income
  12. 2011Commodity-linked shares are a wrapper, a performance-bond, and a hedge-design problem
  13. 2012Hedging an open bull vertical
  14. 2012Construct a two-pair and three-pair hedge rule book
  15. 2014Equity and SPY stress pairs with a scaled index hedge
  16. 2015Yearly at-the-money covered calls on a dividend basket
  17. 2015Pair hedge to hold a valid idea through noise
  18. 2015Unused peer hedge after an ATR-qualified pair entry
  19. 2016Continuous index hedges fail the annual cost test
  20. 2016A VIX overlay as three stacked constraints
  21. 2018Late-cycle index overlay to keep equity dividends
  22. 2019Treat a bear-market hedge as a regime switch
  23. 2019Hedged pairs as game-theory payoffs
By fieldIntermarket and spreads162 readingsBy year198217 readings
All 25 readings tagged Hedging strategy
Also on Hedging strategy5 readings
1990Options as insurance unless the process is complete1996A price-weighted technology index as a hedge and sector proxy2001Financed call ratio repair for a gapped long2002Single-stock futures as a month, margin, and hedge overlay2004Listed volatility futures as a portfolio volatility hedge