Suppose you manage a / $12 million portfolio, currently all invested in equities, and you believe that the market is on the verge of a big, but short-lived, downturn. You could move your portfolio temporarily into T-bills, but you do not want to incur the tax and transaction costs of selling your stocks and re-buying them. Instead, you decide to temporarily hedge your equity holdings with S/&P 500 index futures contracts1) Should you be long or short the contracts? Why? 2) How many contracts should you enter into? The S&P 500 index futures price is now at 1286 and the contract multiplier is $250. 3) Suppose instead of reducing your portfolio beta all the way down to zero, you decide to reduce it to 0.5, how many index futures contracts should you enter into?

Question

Trevin Phelps

Business

21 June, 13:28

Suppose you manage a / $12 million portfolio, currently all invested in equities, and you believe that the market is on the verge of a big, but short-lived, downturn. You could move your portfolio temporarily into T-bills, but you do not want to incur the tax and transaction costs of selling your stocks and re-buying them. Instead, you decide to temporarily hedge your equity holdings with S/&P 500 index futures contracts1) Should you be long or short the contracts? Why? 2) How many contracts should you enter into? The S&P 500 index futures price is now at 1286 and the contract multiplier is $250. 3) Suppose instead of reducing your portfolio beta all the way down to zero, you decide to reduce it to 0.5, how many index futures contracts should you enter into?

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Lorena Simon · Answer 1

1) We should short the contracts because we want to hedge our position in response to the expected downturn in the market, to neutralize our position we need to short the contracts.