Cbapter 30: Stock Index Hedging Strategies 561 
Another risk that the arbitrageur faces is that of changes in the dividend payout 
of the stocks in the index. Suppose that he is long stocks and short futures. If there 
are enough cuts in dividend payout, or dividend payments are delayed past the expi­
ration date of the futures, then he will lose some of his return. Arbitrageurs who are 
short stocks and long futures would have similar problems if dividend payout were 
increased especially if a large special dividend were declared by a company that ,is 
a major component of the index - or payment dates were accelerated. 
If one holds the arbitrage until expiration, he will be able to unwind it at parity. 
However, if he decides to remove the arbitrage before expiration, he might incur 
increased costs that would harm his projected return. Instead of selling his stocks at 
the last sale of the index, as he is able to do on expiration day, he would have to sell 
them on their bids, a fact that could cost him a significant portion of his profit. 
In a later section, where we discuss hedging the futures with a market basket of 
stocks that does not exactly represent the entire index, we will be concerned with the 
greatest risk of all, "tracking error" - the difference between the performance of the 
index and the performance of the market basket of stocks being purchased. 
IMPACT ON THE STOCK MARKET 
The act of establishing and removing these hedge positions affects the stock market 
on a short-term basis. It is affected both before expiration and also at expiration of 
the index products. We will examine both cases and will also address how the strate­
gist can attempt to benefit from his knowledge of this situation. 
IMPACT BEFORE EXPIRATION 
When bullish speculators drive the price of futures too high, arbitrageurs will attempt 
to move in to establish positions by buying stock and selling futures. This action will 
cause the stock market to jump higher, especially since positions are normally estab­
lished with great speed and stocks are bought at offering prices. Such acceleration on 
the upside can move the market up by a great deal in terms of the Dow-Jones 
Industrials in a matter of minutes. 
Conversely, if futures become cheap there is also the possibility that arbi­
trageurs can drive the market downward. If positions are already established from 
the long side (long stock, short futures), then arbitrageurs might decide to unwind 
their positions if futures become too cheap. They would do this if futures were so 
cheap that it becomes more profitable to remove the position, even though stocks 
must be sold on their bid, rather than hold it to expiration or roll it to another series.