If the S&P contracts have a multiplier of $500 and your $2.0M hedge fund stock p

Question

If the S&P contracts have a multiplier of $500 and your $2.0M hedge fund stock portfolio has a beta of 1.2, then your portfolio position can be hedged from overall stock market volatility for 3 months by selling how many S&P futures contracts beginning of the quarter? Assume the S&P index is at 1,200 and for simplicity, your portfolio pays no dividends.

Assume if your portfolio alpha is 4%. What would be your portfolio return if the stock market declines by 10% during the quarter? Explain your answer.

Explanation / Answer

We have:

Multiplier = $500

Current index = 1200

Size of hedge fund portfolio = $2,000,000

Size of one index contract = multiplier x current index

                                         = $500 x 1200

                                         = 600,000

Beta = 1.20

No. of contracts needed to hedge the portfolio = Size of hedge fund x Beta/ Size of one index contract

                                                                      = $2,000,000 x 1.20 / $600,000

                                                                       = 4 contracts

Portfolio return = Market return + Alpha

                         = -10% + 4%

                         = -6%

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