Hedging strategy

 

FIN567 – Class Project

Assume that you have $500,000 to invest in equities and want to establish a new portfolio

that includes ten (10) stocks to be selected from the Dow Jones Industrial Average of 30 

companies.  It is also desired to start with nearly equal dollar values of each issue.  Use 

current market prices to compute the number of shares required. 

You are bullish on the markets in the long-term; however, you have read analyst 

predictions that over the next 18 months the market will likely stay flat with some 

downside potential.  Despite these predictions, you want to make some money in the 

short-term, and at the same time avoid any downside spikes in the markets.  A hedging 

strategy using options and/or futures seems appropriate.  Please develop a plan to 

accomplish your goal and give a detailed explanation, with numerical computations, of 

the upside opportunities and the downside risks for each chosen position.

In addition to your investment in equities, you also have $1 million dollars to invest 

conservatively in U.S. Treasury issues and money market securities.  Select four T-bonds 

and/or T-notes ranging in maturity from two years to five years and purchase equal dollar

amounts with a total of approximately $500,000.  Invest the remaining $500,000 in the 

money market.  You need not select individual money market issues; just assume that the 

money market investments are secure and return the risk free rate.  Please discuss the 

how the inclusion of the fixed income securities affects the risk in your total portfolio.

To begin the project you need to select 10 stocks and fixed income issues.  When buying 

large quantities of stocks, it is most usual and convenient to issue orders in round lots 

(rounded to 100 shares).  You should do this for your analysis. When you sum the value 

of the rounded lots, the result will almost certainly not be exactly $500,000.  Ignore that 

difference and use the sum of the rounded lots as your equity investment.  The same 

holds true for the fixed income selections.  A spreadsheet is provided in Doc Sharing to 

help you do the required computations.

                    OPTIONS & FINANCIAL FUTURES MARKETS

                                          PROJECT GUIDELINES

General Guidelines

This project is about quality and substance, not about volume.  Your narratives should be concise, comprehensive, and easy to read.  APA format is required.  Your pricing numbers for derivatives must be expressed in a spreadsheet format.  Your presentation should be in the following order:

1.  Executive Summary

2.  Explanation of Hedging Strategy

3.  Spreadsheet

4.  Explanation of the strategy’s risks and rewards 

5.  Conclusion

Executive Summary

This narrative should be a brief explanation of the objective, strategy, and conclusion.  There need only be enough information to provide a reader an overview of the issue, your approach, and your perceptions on how you will benefit.

Spreadsheet

For every derivative security you select as a part of your strategy, there should be a spreadsheet entry identifying the derivative, and all purchasing or selling elements, e.g. strike price, expiration, and costs.  You should also show possible outcomes.  Example, if you recommend selling a call option, then show the net results if the underlying stock moves down, stays flat, and rises above the strike price.  The net results should be expressed in net dollars (actual return or loss), actual percentage gain or loss, and annualized percentage gain or loss.

Risks and Rewards

This is a narrative based on the probabilities shown in your spreadsheet.  You should provide a brief explanation of the outcomes should the market decline, stay flat, or rise.

Conclusion

This is your opportunity to express your professional opinion that your strategy will enhance your portfolio.