40 lines
3.1 KiB
Plaintext
40 lines
3.1 KiB
Plaintext
Cbapter 30: Stock Index Hedging Strategies 565
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However, this flurry of block prints on the close might drive the index down by 2 or
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3 points! This is an extremely large move for the index, and the option trader has no
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recourse as the options cease trading. An index composed of only a few stocks, such
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as the Dow-Jones 30 Industrials, will fall most dramatically when these events occur,
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although the OEX will drop heavily as well.
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We have also previously seen that the late market action on expiration day might
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be bullish. If institutional arbitrageurs have established the futures spread by being
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long the short-term futures and short the next series, then they will be buyers of
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stocks at the close of trading on expiration day. Additionally, if the only remaining
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arbitrage positions at expiration are short stocks versus long futures, then there might
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also be buying pressure at expiration.
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As might be expected, these events have not gone unnoticed and have caused
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some consternation among both regulators and traders. There have been accusations
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that some traders particularly those with foreknowledge of the block prints to come
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buy very cheap index options on the last afternoon of trading and then force those
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options to become profitable by selling their clients' portfolios in the manner
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described above.
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The strategist cannot be concerned with whether someone is acting irrationally
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or worse. Rather, he must decide how he will handle the situation should it occur.
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The key is to try to determine the direction that the market will move at the close of
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expiration day, if that is discernible. If futures have had a large premium for a long
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period of time, then one must assume that many hedgers have long stock versus short
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futures. Furthermore, even if futures subsequently trade below fair value, there will
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still be some hedgers who have stubbornly kept their positions, waiting to roll. The
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strategist should recognize that fact and take appropriate action late on the last day
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of trading: Don't establish bullish positions at that time and don't allow positions that
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are expiring that day to become too bullish. That is, if one is short puts and the index
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is trading near the striking price of the puts, then buy them back.
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Thus, the strategist must be aware of how the futures have traded during the
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last 3 months in order to determine how he will address his positions on the last day.
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Even with this information, there is no guarantee that one can exactly predict what
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will happen at expiration unless one is privy to the actual stock buy and sell orders.
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This order flow information is closely guarded and known only to the firms that will
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be executing the orders, generally on behalf of institutions. Consequently, it is a very
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risky strategy to attempt to apply this information for establishing positions on expi
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ration day itself. That is, if one expects stock buy orders at expiration, he might
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decide to buy some cheap, expiring calls for himself on the last afternoon of trading.
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Conversely, if he expects stock selling, he might buy puts. Given the fact that such
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movements are hard to predict, such aggressive strategies are not warranted. |