It is now January 1 and XYZ stock is trading for $150.00 per share. You own 100 shares of XYZ stock and believe that a short-term (three-month) decrease in price in likely. You decide to sell one March XYZ future, which is currently trading for $151.50. If the stock does decline in price, you will incur a loss on your stock position. This loss, however, will be offset by a profit from a decrease in the price of your short XYZ future. On the other hand, if the price of XYZ stock rises unexpectedly, any loss incurred from your short futures contract can be offset by the increasing value of your XYZ shares. Your risk on the upside will be primarily in the form of opportunity loss.

Two months after you sell your March XYZ contract, XYZ stock has decreased in price and is currently trading for $135 per share. You think the stock price has stabilized, and decide to buy (close out) your short futures contract for an available price of $135.50. The $15 per share unrealized loss* of your XYZ stock ($150 purchase price – current $135 price) will be offset by a $16 profit* ($151.50 sale price - $135.50 purchase price) on your short future position. Once the short future position has been closed out (purchased), your XYZ stock is unhedged. You will suffer a loss if it declines in price, but will profit if it increases in price.

A month after you sell your March XYZ contract, XYZ stock has increased in price and is currently trading for $160 per share. At this point you buy (close out) your March XYZ contract at a market price of $161. The $8.50 loss* ($161.00 purchase price - $151.50 sale price) you have incurred on the short future will be offset by a $10 profit* per share ($160 current price - $150 purchase price) on your long stock position.

* Exclusive of commissions and other transaction costs, margin requirements, and taxes.

Note: Security futures products are not suitable for all investors. Futures trading involves substantial risk of financial loss and should be considered carefully before making any trades.