Question

1. (Chapter 2) Alison is an active portfolio manager attempting to beat the S&P 1500 index regardless of how the index performs. Based on her current holdings, if the S&P 1500 index return is negative, her portfolio will beat the benchmark by 2%. However, if the S&P 1500 index return is positive, her portfolio is likely to underperform, earning only 90% of the index returns. What type of position in SPR index options or futures could Alison add to her current holdings in order to achieve her goal?

Answer 1

ANSWER DOWN BELOW. FEEL FREE TO ASK ANY DOUBTS. THUMBS UP PLEASE.

As an active portfolio manager, the goal of the portfolio manager is to beat the Index.

When The S&P1500 is in negative, the fund over-performs. So it achieves its goal.

However, When The S&P1500 is in Positive, the fund underperforms.

In that case to enhance the value of the portfolio during the time when the market rises Alison can buy Call options when high strike price (Out of money, Deep Call options).

In that case, the premium is also less & she also achieves her objective.

When the market is up, she gains from the call option.

When the market is down, the call option lapses. As the premium is cheap, Alison portfolio is not very affected.

Hence Goal achieved.