ELIF how a market neutral long-short portfolio is equitized

The CFA reading simply glosses over this process in less than a page, as in most cases :neutral_face:, and I’m not completely understanding this process. Could someone explain to me as if I don’t do this for a living. Thanks!

As a follow-up up, how are long-short portfolios market neutral? Is this just a theoretical axiom or is this really how it is done in practice?

Think of a pair trade where you go long a stock with a beta of 1.2 and then short a stock with a beta of 1.2. You’re left with 0 beta. No market risk. Hence market neutral.

Yep, but you didn’t answer how is equitized and therefore reach alpha? As I could recall it retain some alpha exposure, maybe through derivatives.

Sorry, buy an SP500 futures contract

I will, but rather prefer SPX ETF, $SPY for example.:slight_smile:

Yes, you buy a fully collateralized Futures contract. Could be on any index, or asset class.

Lol do as you wish flashback but I believe curriculum typically associates using futures with the strategy. For sp500 I suppose it’s a mute point.

I’m pretty sure if you use an ETF, it’s no longer a synthetic position. Unless you are doing some type of return swap being collateralized, but then you end up paying more anyways. But if they state futures are more expensive, then BOOM you win!

winner winner chicken dinner

You are wrong. Look for synthetic ETFs. Those are marked with X. Well, $SPY is not good example. Maybe $VXX Ultra short SPX Futures ETN.

interesting read on synthetic ETFs, kind of sounds like a niche of managed futures though what I read also said they use swaps as well which I kind of felt was odd. Then again CDX don’t trade the same as CDS, which in itself is bizarre to me.

Anyways thanks that was good to know that something like that exists for IRL

Hmmm I wonder how they use swaps? Interesting…trying think that through. I’ll have to look it up.

Synthetic ETFs use SWAPS instead of redemption of basket of underlying assets. How exactly they use SWAPS, I don’t know. Try to research. Interesting, there is nothing about that in CFAI Curriculum and ETFs are more popular than some other financial instruments explained in more detail through L1-L3 curriculum.