39 lines
3.1 KiB
Plaintext
39 lines
3.1 KiB
Plaintext
Chapter 30: Stock Index Hedging Strategies 559
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However, on the last day of trading, the cash-based index product will expire at
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the opening price of the index. If one were to sell out his entire market basket of
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stocks at the current bid prices at the exact opening of trading on that day, he would
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sell his market basket at the calculated last sale of the index. That is, he would actu
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ally be creating the last sale price of the index himself, and would thereby be remov
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ing his position at parity.
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The problem with this is that it is correct theory, but difficult to put into prac
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tice. For example, if one has several million dollars of stocks to sell, he cannot expect
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the marketplace to absorb them easily when they are all being sold at the last minute
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on a Friday afternoon. We will discuss this more fully momentarily, when we look at
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the impact of stock index arbitrage on the stock market in general.
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There is another interesting facet of the arbitrage strategy that combines the
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spread between the near-term future and the next longest one with the idea of exe
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cuting the stock portion of the arbitrage at the close of trading on the day the index
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products expire. Use of this strategy actually allows one to enter and exit the hedge
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without having to lose the spread between last sale and bid or last sale and offer in
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either case. Suppose that one feels that he would set up the arbitrage for 3 months if
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he could establish it at a net price of 1.50 over fair value. Furthermore, if the fair
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value of the 3-month spread is 2.10, but it is currently trading at 3.60, then that rep
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resents 1.50 over fair value. One initiates the position by buying the near-term future
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and selling the longer-term future for a net credit of 3.60 points. At expiration of the
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near-term future, rather than close out the spread, one buys the stocks that comprise
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the index at the last sale of the trading day, thereby establishing his long stock posi
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tion at the last sale price of the index at the same moment that his long futures expire.
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The resultant position is long stocks and short futures that expire in 3 months at a
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premium of 3.60. Since the fair value of such a 3-month future should be 2.10, the
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hedge is established at 1.50 over fair value. The position can be removed at expira
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tion in the same manner as described in the previous paragraph, again saving the dif
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ferential between last sale and the bids of the stocks in the index. Note that this strat
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egy creates buying pressure on the stock market at expiration of the near-term side
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of the spread, and selling pressure at the latter expiration.
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The final way to exit from one's position is to remove it before expiration.
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Sometimes, there are opportunities during the last two or three weeks before the
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futures expire. If one hedged with long stock and short futures, the opportunities
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to remove the hedge arise when the futures trade below fair value - perhaps even
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at an actual discount to parity. If the futures never trade below fair value, but
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instead continue to remain expensive, then rolling to the next expiration series is
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often warranted. |