I understand the synthetic stock thing. The problem is - client is expecting after 3 month stcok going down. If we hold synthetic stocks, 3 month later, we end up with stocks in hand. Why?!
No we dont. He wants to synthetically hold them for 3 months and then be rid of them. Using futures he will be exposed to the stock market adn then at the end he will have his cash again…You dont get stocks when futures expire.
ok, let me try stupid question to clear my head: if he holds future and cash, after 3 month, when future expire, since he is long, he will buy stocks at the future price, and end with stocks? help!
? help!
he will settle with cash
If he long future, he will pay cash to get stocks according to future price, right?
could you paste the whole question?
ditto what csk said – he’ll just cash settle the futures, or really just close out the position by entering into an offsetting (short) trade prior to the futures expiration. at the end of it he won’t have stock, but cash.
MaxTheDog, ok, that’s fine, but that’s a bit of our own “add-on”. Jpd: the question is, if a client is opt 3m of stocks, but pess after that, and he has cash in hand, what should he do? Answer is long bond, and long future. So my question is, if I don’t close out future, and let it expire, I will pay cash, and get stocks, why?
Fair to question the mechanics of it. True, you will own enough T-Bills to cover the futures value at expiry. Remember though that the future is just a contract - at expiry a settlement will take place which can either be cash settlement (i.e. no delivery/transfer of underlying) or physical. In the case of securities the norm, I believe, is cash settlement, i.e. a one-time payment from the buyer or seller of the future, depending on what the spot price is. I would just assume that securities are cash, particularly indices (physical delivery would be inconvenient or impossible. For example, an option on a basket of stocks, such as the S&P 500, would entail considerable transaction costs otherwise). Hope that helps!
Aren’t the index futures cash settled? I know the E-Minis are and always assumed the standard index futures were as well.
ok, if we settle againt another future, then we are fine with cash at the end.
what i’m saying is that the contracts are cash settled by definition. even if you don’t enter into an offsetting transaction, you end up with cash at settlement, not all the stocks in the s&p500 at their index weights (that’d be way too unwieldy).
I saw on the CFAI books that “you end with stocks in hand…” can find out tonight.
interesting…seems to go against reality unless they’re assuming you go and invest the cash settlement proceeds plus the risk-free bond in the underlying shares at contract expiration. (or, of course, i could be wrong about cash settlement!!) pls let me know if you find the reference.
This was bothering me…so… In the Chance derivatives book, p 102: “Given the impracticality of delivering a portfolio of 500 stocks in the index combined according to their relative weights in the index, the contract is structured to provide for cash settlement at expiration.” Knew I’d seen that somewhere…