Financial Education

Trading illiquid stocks or baskets of stocks can take time, resulting in an opportunity cost while the trade is being executed. Some of this opportunity cost can be reduced by executing a futures trade while the stock trades are being processed. For example, an investor with a global portfolio that wants to reduce exposure to Japan could sell futures on the Japanese index rather than selling the stocks in the portfolio. If the stocks are subsequently sold, the futures position could be reduced by a similar amount.

The risk to this strategy is that the stocks in the portfolio are not strongly correlated to the corresponding index. If the stock declines and the index advances, the portfolio would lose on both ends of the trade. The strategy is most suitable for passive investors or for active managers willing to accept that risk.

For more information, see all articles on: Active Management, Investing in Stocks, Passive Management, Portfolio Management

See also:

Creating an Index Portfolio Using Index Futures

The Role of Derivatives in Rebalancing

Principal Trades

Investing in Commodities

Using Futures to Alter Risk in Fixed Income Portfolios