36 lines
2.6 KiB
Plaintext
36 lines
2.6 KiB
Plaintext
566 Part V: Index Options and Futures
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SIMULATING AN INDEX
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The discussion in the previous section assumed that one bought enough stocks to
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duplicate the entire index. This is unfeasible for many investors for a variety of rea
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sons, the most prominent being that the execution capability and capital required
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prevent one from being able to duplicate the indices. Still, these traders obviously
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would like to take advantage of theoretical pricing discrepancies in the futures con
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tracts. The way to do this, in a hedged manner, would be to set up a market basket
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of a small number of stocks, in order to have some sort of hedge against the futures
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position.
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In this section, we will demonstrate approaches that can be taken to hedge the
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futures position with a small number of stocks. This is different from when we looked
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at how to hedge individualized portfolios with index futures or options, because we
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are now going to try to duplicate the performance of the entire index, but do it with
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a subset of stocks in the index. In either of these cases, a mathematical technique
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called regression analysis can be used to measure the performance of these portfo
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lios or small market baskets. However, we will take a simpler approach that does not
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require such sophisticated calculations, but will produce the desired results.
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USING THE HIGH-CAPITALIZATION STOCKS
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Recall that in a capitalization-weighted index, the stocks with the largest capitaliza
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tions (price times float) have the most weight. In many such indices, there are a
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handful of stocks that carry much more weight than the other stocks. Therefore, it is
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often possible to try to create a market basket of just those stocks as a hedge against
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a futures position. While this type of basket will certainly not track the index exactly,
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it will have a definite positive correlation to the index.
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What one essentially tries to accomplish with the smaller market basket is to
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hedge dollars represented by the index with the same dollar amount of stocks. No
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hedge works in which the total dollars involved are not nearly equal. Listed below are
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the steps necessary to compute how many shares of each stock to buy in order to cre
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ate a "mini-index" to hedge futures or options on a larger index:
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1. Determine the percent of the large index to be hedged (OEX, NYSE, S&P 500,
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etc.) that each stock comprises. This information is readily available from the
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exchange on which the futures or options trade or can be calculated by the meth
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ods shown in Chapter 29.
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2. Determine the percent of the mini-index to be constructed that each stock com
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prises, by inflating their relative percentages to total 100%. |