I have a stupid question.
You basically do a pairs trade plus buy futures contract that is collateralized with cash. I just don’t know how that works.
Let’s say you think ford is undervalued and gm is over valued.
You would short gm and buy ford. Let’s say you short 1000 worth of gm and buy 1000 worth of ford. You have a beta of 0 or near 0.
Are you supposed to get additional cash for the futures? The way it reads it seems like you take the proceeds from the short sell of gm and buy BOTH ford and futures.
Am I missing something or is it just too late and I’m thick?
I was somewhat lost when I saw the topic and so I hopped onto google and stumbled upon this link, which is a previous discussion on equitizing a market-neutral position:
https://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/9896127
In case you don’t have the time to go through it, the gist of this strategy is as follows:
Taking the example you’ve given, let’s assume that you’ve spent $1mn to buy Ford shares.
Let’s also assume that you’ve got $1mn from shorting GM shares.
In effect, you’ve eliminated systematic risk (beta) of these positions.
If you weren’t going to equitize this trade, you’d hold this money in Treasuries/cash equivalents.
If you’re going to equitize this trade, you’ve forecasted that the market is going to go up and you want in on the gains. If so, rather than invest the proceeds from the “short GM” position in cash, you’ll buy futures on the S&P500 index.
Hope this helps.
Equitized market neutral typical combines cash management from the short position and derivatives per schweser. The alpha is generated from the management of the cash.