Question

A fund manager has a portfolio worth $50 million with a beta of 0.87. The manager is concerned about the performance of the market over the next two months and plans to use three-month futures contracts on the S&P 500 to hedge the risk. The current level of the index is 1250, one contract is on 250 times the index. The current 3-month futures price is 1259.

1) What position should the fund manager take to eliminate all exposure to the market over the next two months?

2) What position should the fund manager take to change the portfolio to be a reverse double leveraged index ETF over the next two months?

Answer 1

1) To hedge the position, the fund manager should sell S&P futures contracts. To hedge the exposure completely,

No. of contracts to be sold = Beta of the portfolio * Value of portfolio/ value of one futures contract

= 0.87* $50 million / (1259*250)

=138.20

So, the fund manager should sell 138 S&P contracts to completely hedge the exposure

2) For the portfolio to be a reverse double leveraged index ETF , the beta of the portfolio should become -2

No. of contracts to be sold = Change in Beta of the portfolio * Value of portfolio/ value of one futures contract

= (0.87 - (-2))* $50 million / (1259*250)

=455.92

So, the fund manager should sell 456 S&P contracts to make the portfolio a reverse double leveraged index ETF