Which of the following is NOT an advantage of the short extension strategy compared to a long only strategy or a market neutral strategy? A) A short extension strategy does not utilize swaps or futures. B) The market return and alpha for the short extension strategy are generated from the same source. C) A short extension strategy can short a small cap stock that may have a minimal weight in a market capitalized benchmark. Still a little rusty on the concept, I’ll post the answer in a bit.
B
B
B With short extension your limited on what assets you can short.
B for me too
B
b
B
Everyone is right, herding behavior? Your answer: A was incorrect. The correct answer was B) The market return and alpha for the short extension strategy are generated from the same source. In a short extension strategy the market return and alpha are generated from the same source – the market return comes from the long position in equities and the alpha comes from shorting those same overpriced/underperforming equities and using the proceeds to invest in undervalued securities. This is a disadvantage because it is more limiting and constraining as compared to the market neutral position which generates alpha by going long and short in under and overpriced securities respectively in the same industry and then using derivatives such as equity index futures to gain market exposure. Thus in the market neutral strategy the alpha and market exposure are gained from different sources. A disadvantage of a long only strategy is the constraint of only being able to reduce the weight of a poorly performing stock to zero in the portfolio. If the benchmark is market capitalized the effect on the portfolio is minimal for small and mid cap stocks. Conversely, a short extension strategy can short the same under performing small or mid cap stock in a greater proportion and exploit the negative information regarding the stock to a much larger degree than the long only strategy. A short extension strategy does not rely on the available liquidity of swaps and futures to gain market exposure as the market neutral strategy does.