Market netraul 1. own stock 2. Short it (who get dividend)? 3. Invest in long futures 4. Earn risk free (from holding futures or borrowed stocks) Right? Other source of return?
Market neutral just means your long betas and short betas match up in the portfolio to 0 so that you are not taking any systemic risk. All of your returns should be considered alpha
What you are referring to is using a forward/futures strategy to monetize a stock position.
How then you get return if you long and short the same instrument? Could you please explain
I mean and where Risk free come from?
You have GOOGLE stock for $1000, you see that AAPL is undervalued and want to make some money, but GOOGLE is a nice stock that you like and you won’t sell any.
So you create money from GOOGLE, by short selling someone else’s stock for $1000, take that money and buy AAPL, when AAPL shoots up high, you sell it, buy back GOOGLE (the price it’s at now won’t matter because you’re long+short), and continue with your GOOGLE investment of 1000 + made from AAPL. And you never had to sell the stock.
And what about risk free? It is important here since also benchmark shloud be risk free?
i asked this on another thread, is there anyway to get the GOOG dividends tax free to pay the short?
somehow take a capital loss on the short and pay tax on the AAPL dividends?
if you have no systematic risk, than you would earn the risk free rate. It’s been the standard since level 1 that the CFAI will use the risk free rate for anything related to 0 systematic risk.
Yes, know that theory…But how you really earn it?
The benchmark for the long and short is risk free since you get the $1,000 back and could invest it in risk free assets.
But you likely will have to pay it to the short lender, plus the dividends you earn from the long, so you’re net is actually zero. But that’s not implicit in the CFAI, they assume shorting has a zero interest cost.
I don’t follow, you’re still long on the amount for GOOG, you simply divert the divs to the short lender.
it’s all part of the theory. you think the risk free rate is some type of vehicle? In real life the closest thing to it are money market rates and 90 day T Bill
i googled it…
If you borrow stock to make a short sale, you may have to remit to the lender payments in lieu of the dividends distributed while you maintain your short position. You can deduct these payments only if you hold the short sale open at least 46 days (more than 1 year in the case of an extraordinary dividend as defined below) and you itemize your deductions.
my point was you’re receiving 2 sets of dividends, so you could be liable for tax on both.this point isn’t touched in the cfai texts.
You’ll be tax liable on both naturally, since you’re long both stocks. But you’ll only pay the before tax dividends of the short matching stock to the lender.
I might be wrong but i can give it a try:
The proceeds from short selling the stock would be held with the broker and invested in Treasury to earn a so-called risk-free rate. And you would get the interest earned on Treasuries. (Of course, here we ignore the cost of borrowing the shares to sell in the first place, which in practice should be higher than the risk free rate. But it’s not mentioned in CFAI so please ignore that).
The collateral is usually small. And in this case, you get to keep all the procedds, and maybe even put out all the collateral in the form of stocks for a 100% cover. But in this case, it doesn’t really matter.