36 lines
2.5 KiB
Plaintext
36 lines
2.5 KiB
Plaintext
Cbapter 30: Stock Index Hedging Strategies 547
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paid out and, if the market stabilizes, the time value decay will cause a loss on the
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puts. If one actually suspects that such a stabilization might occur, he should use
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futures against his position instead of puts or calls.
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INDEX ARBITRAGE
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As previously stated, index arbitrage consists of buying virtually all of the stocks in an
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index and selling futures against them, or vice versa. Whenever the futures on an
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index are mispriced, as determined by comparing their actual value with their fair
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value, there may be opportunities for arbitrage if the mispricing is large enough.
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When futures are extremely overpriced: buy stocks, sell futures; or when futures are
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underpriced: sell stocks, buy futures. In either case, the arbitrageur is attempting to
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capture the differential between the fair value price of the futures contract and the
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price at which he actually buys or sells the index. First, we will examine fully hedged
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situations - ones in which the entire index is bought or sold. After that, we will exam
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ine smaller sets of stocks that are designed to simulate the performance of the entire
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index.
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Hedging indices which contain fewer stocks is easier than hedging larger
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indices. Hedging a price-weighted index is probably the simplest type of hedge. As
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examples, the same sample indices that were constructed in the previous chapter will
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be used.
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Whenever futures or index options trade on an index, it is possible to set up
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market baskets for arbitrage. The trader should determine, in advance, how many
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shares of each stock he will buy or sell in order to duplicate the index. In a price
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weighted index, of course, he will buy the same number of shares of each stock. In a
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capitalization-weighted index, he will be buying different numbers of shares of each
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stock. Let us first look at how the number of shares to buy is determined. Then we
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will discuss some of the nuances, such as monitoring bids and offers of the indices,
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order execution, and others.
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HOW MANY SHARES TO BUY
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In advance of actually trading the stocks and futures or options, one should deter
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mine exactly how many shares of each stock he will be buying in each index he plans
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to arbitrage. Normally, one would decide in advance how many futures contracts or
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option contracts he will trade at one time. Then the number of shares of stock to be
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bought as a hedge can be determined as well. Essentially, one is going to hedge equal
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dollar amounts - that is, he will buy enough stocks to offset the total dollar amount
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represented by the index. |