“Long-short is one way to achieve market neutrality. A manager would own stocks (long) believed to be undervalued and short stocks believed to be undervalued. The long and short positions are sized to remove any exposure to overall market direction. For example, if the long and short positions have the same beta, then their size will be equal. The short sales fund the long positions and the portfolio holds cash. To add market exposure, long equity futures equivalent to the portfolio’s cash holdings are purchased and the cash fully collateralizes the contract position. The portfolio return is: -The risk free rate earned on the cash (equivalent) holdings. -The market return on the futures contracts. -The spread earned on the long-short positions.”
So I’m clear up to the underlined portion. A few questions: 1) if the proceeds from the short sales fund the long positions, where does the cash in the portfolio come from? 2) Why do the futures contracts need to equal the cash amount? I thought futures did not need an initial cash outlay. Is the cash posted against the future the margin required as per the futures contract? 3) Where does the risk-free rate earned on the cash come from if the cash is collateralized against the futures contract? Apologies for the basic questions, but I’ve never really grasped futures.
you cannot start this strategy with 0 cash at all (i.e. for free), you still require investment outlay at the start.
just like when you want to invest in a long-only equity portfolio, you buy shares using cash.
the difference here is that in the case of market neutral long-short portfolio, you can use this cash to either:
enter the long position first and short position later. this means you don’t follow the underlined explanation of schweser. the proceeds from the short position becomes the “new” cash in your account.
invest the cash in money market instruments and follow the first sentence of the underlined part.
either way, both leads to equal outcome (i.e. a position in cash, a position in long equity, a position in short equity)
it would be too good to be true if you can start this strategy while being broke and essentially earn the manager’s alpha of the portfolio’s notional amount.
Are you saying in order to do a short sale - you’re required to outlay some cash?
If you don’t, theoretically you’d be able to do a short sale and use the cash proceeds from the short to go long on whatever you’d like. Hence, you’d have a portfolio where you’re achieving two alphas - you just wouldn’t be earning the return on the futures or the Rf with the cash. This would be a market-neutral long-short strategy. I think what for equitizing the long-short position you’d need cash.
Yo Geoff. Ever have an etrade account dude? You don’t need to spend your cash to short, you just gotta get dat paper on margin! Margin requires a cash balance! What my man above was tryin ta explain to you. Just think, think about it.
Yo Geoff. Ever have an etrade account dude? You don’t need to spend your cash to short, you just gotta get dat paper on margin! Margin requires a cash balance! What my man above was tryin ta explain to you. Just think, think about it.
realistically, short selling would be highly regulated or outright forbidden. otherwise, it would cause a market that is already on fire to burn even brighter and hotter. when it comes to regulations, perhaps there’s requirements such as proof of having the long position first, margin deposit, accredited investor’s license or a cash collateral.
imagine if the long and short positions are 100 USD each and the manager earns an alpha of 2% for each direction. seems too good to be true if you can get 4 USD (before taxes and fees) out of nothing if you don’t put up a cash outlay at the start. if you can do that, why stop there? why not put up a portfolio with 1 billion USD principal in each direction and earn 40 million USD out of nothing.
imagine a homeless person reading this right now and run up to a prominent asset management firm’s office such as UOB or Schroder’s and ask for this strategy to make him money out of nothing.