38 lines
2.9 KiB
Plaintext
38 lines
2.9 KiB
Plaintext
532 Part V: Index Options and Futures
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The key to determining whether it will be profitable to trade some derivative
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security - options or futures - against a set of stocks is generally the level of premi
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um in the futures contract itself. That is, if the S&P 500 Index is at 405.00 and the
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futures are trading at 408.00, then there is a premium of 3.00 - the futures contract
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is trading 3.00 points higher than the index itself. The absolute level of the premium
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is not what is important, but rather the relationship between the premium and the
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fair value of the future. We will look at how to determine fair value shortly.
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The futures are the leaders among the derivative securities, especially the S&P
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500 futures. Whenever these become overpriced, other derivative securities will gen
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erally follow suit. There are also futures on the NYSE Index, the Value Line Index,
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and the Japanese Nikkei 225 Index. Moreover, there are cash-based index options on
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the S&P 500 Index (as opposed to the futures options on that index) and the NYSE
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Index. These other securities would include the QEX (S&P 100) options and NYSE
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futures and options. It follows as well that when the S&P 500 futures become under
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priced, the other derivative securities quickly fall into line. If the other derivative
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securities don't follow suit, then there is an opportunity for spreading one market
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against another. That type of spreading can frequently be profitable, and is discussed
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in the next chapter.
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The normal scenario is for most of the derivative securities to follow the lead of
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the S&P 500 futures. When this happens, the only thing that is fairly priced is the
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index itself - that is, stocks. Consequently, the logical way to hedge the derivative
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security is to do it with stocks. The small investor might hedge his own individual
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portfolio, although that would not be a perfect hedge since his own portfolio is not
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composed of the exact same stocks as any index. If the index is small enough, such as
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the 30-stock DJX, then one might buy all 30 stocks and sell the futures when they are
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overpriced. This is a complete hedge and would, in fact, be an arbitrage. In the case
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of a larger index such as the S&P 500, it would be possible only for the most profes
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sional traders to buy all 500 stocks, so one might buy a smaller subset of the index in
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hopes that this smaller set of stocks will mirror the performance of the index well
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enough to simulate having bought the entire index. We take in-depth looks at both
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types of hedging.
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Even if the investor is not planning to use these hedging strategies, it is impor
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tant for him to understand how they work These strategies have certain ramifications
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for the way the entire stock market moves. In order to anticipate these movements,
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a working knowledge of these hedging strategies is necessary. The first thing that one
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must know in order to implement any of these hedging strategies is how to determine
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the fair value of a futures contract. |