Equitizing a Market Neutral Long Short Position

CFA Readings #31 p132 Equitizing a Market Neutral Long Short Position - can anyone put this in laymans terms? (1) Short shares (q1: what shares? does it matter?) Get some money from Short sell - like $10M (2) Enter a Futures Contract (Long) (q2: on what? for a notational amount of $10M {No cash changes hands here, right?} (3) Invest Cash in Money Market Total Return = Shorted Gains/Losses + Return on Futures contact + Return on Money Market Cash q3: What is the benefit of this strategy? q4: how do you close it out?

I understand it like this LONG / SHORT Position has no systematic risk. so you use futures to Equitize that position and gain systematic exposure.

I agree with Mr.Good.Guy


yea all this is true but what are the benefits? I mean I know you get alpha from the long/short and the beta for the market but why is that a benefit?

Cuase at parties you can talk about your cool market equitizing strategy. DUH!!

I think it has to do with the fact that you can act on downside information (negative impacts to a investment) that are restrictive to a Long Only strategy while at the same time maintaining risk to the overall market systematic risk. (THATS MY GUESS)

here how it works, say you discovered some shares that are overvalued and you want to exploit such a mispricing, however, you don’t want to have any market exposure First, you borrow these shares from your broker and short them (you’ll have to pay margin fees to the broker for that) After your short, you get dollars back for selling these shares. Second, you have to find an instrument that have similar market exposure to the shares that you just shorted, and buy futures on that instrument, To ilustrate the point, lets say, you determined that S&P500 is overvalued and you shorted ‘SPY’ (S&P 500 ETF). Now you would buy S&P futures with a notional amount of SPY that you shorted. When you buy S&P futures, you deposit the cash that you received from shorting SPY into margin account (or you can buy T-bills and put them as margin), that will be used to settle your daily market-to-market positions. At the end your Total Return = gains/losses from shorting SPY + gains/losses on S&P futures + Return on Money Market (that was put in the margin account) My example is rather simplistic since your buying and shorting esentially the same instrument, but the real strategy would work where you are shorting stocks A, B, C and then buying futures on index Z that has same market exposures that A, B, and C combined, and that brings your beta closer to 0 and makes it market-neutral, while still alowing you to capture alpha

Thanks Volkovv! Your answer is MUCH appreciated! BTW - when I take this again next year, can I buy your Study Guide? ;-D

glad I could help