Chapter 30: Stock Index Hedging Strategies 577 
that leads the investor to believe that the group no longer has the potential to out­
perform the market. 
If the futures are underpriced when one begins to investigate this strategy, he 
should not establish the position. What is gained in tracking error could be lost in 
theoretical value of the futures. Since one is establishing both sides of the hedge 
(stocks and futures) at essentially the same time, he can afford to wait until the 
futures are attractively priced. This is not to say that the futures must be overpriced 
when the position is established, although that fact would be an enhancement to the 
position. 
If one thinks that a particular group will underperform the market, he merely 
needs to decide how many shares of each stock to sell short and then can determine 
how many futures to buy against the short sales in order to try to capture the track­
ing error. If one decides to capture the negative tracking error in this manner, he 
must be careful not to buy overpriced futures. Rather, he should wait for the futures 
to be near fair value in order to establish the position. 
COLLATERAL REQUIREMENTS 
In any of the portfolio hedging strategies that we have discussed in this section, there 
is no reduction in margin requirements for either the futures or the options. That is, 
the stocks must be paid for in full or margined as if they had no protection against 
them, and the hedging security - the futures or options - must be margined fully as 
well. Long puts would have to be paid for in full, short futures would require their 
normal margin and would be marked to the market via variation margin, and short 
calls would have to be margined as naked and would also be marked to the market. 
A trader who has not margined his stocks could use them as collateral for the naked 
call requirements if he so desired. 
SUMMARY 
There have been two major impacts of index futures and options. One is that they 
allow a trader to "buy the market" without having to select individual stocks. This is 
important because many traders have some idea of the direction in which the mar­
ket is heading, but may not be able to pick individual stocks well. The other, perhaps 
more major, impact is that large holders of stocks can now hedge their portfolios 
without nearly as much difficulty. The use of these futures and options against actu­
al stock indices - real or simulated - has introduced a strategy into the marketplace 
that did not previously exist. The versatility of these derivative securities is evidenced