Chapter 8: Trading, Hedging and Investment Strategies Flashcards
What is meant by a futures spread trade?
Buying and selling futures simultaneously.
What are intra-market spreads?
Futures spread trades based on buying and selling with different dates.
An example is buying the near dated future and selling the long dated future
Why may an investor use intra-market spreads?
Basis is expected to strengthen or weaken
Reducing risk
Arbitrage
Roll over on existing hedge
What are inter-market spreads?
Buying different underlying assets (likely correlated).
Why may an investor use inter-market spreads?
When price correlation between 2 assets has broken down
Why is Cheapest To Deliver (CTD) and why is it used to hedge?
CTD is the cheapest bond used when hedging a bond future. CTD is calculated using the bond in the portfolio with the highest implied repo rate.
How would a portfolio be hedged without CTD bonds?
No. of contracts = nominal value of portfolio x duration / (interest rate futures price x duration of underlying asset in future rate)
How do you hedge bond futures using CTD?
No. of contracts = price factor x (nominal value of CTD portfolio)/ nominal value of the contract
What does the beta of a portfolio represent?
Beta is the measure of a portfolios volatility relative to the markets.
What is the hedge ratio?
No. of contracts = portfolio size / contract size
What is the hedge ration when beta != 1?
No. of contracts = (portfolio size / contract size) x beta
What is a covered short put position?
Short on underlying and sell a put option. PM will provide protection against price increase, ut profit will be capped if price decreases.
What is a covered short call? Why would a trader execute a covered short call position?
Long underlying positon with a short call position. Seller will receive premium as well as the underlying option returns up to the strike price.
What are the 3 different types of option spreads and how are they constructed?
Vertical spread - buying and selling calls with different strikes
Horizontal spreads - buying and selling options with different expiry
Diagonal spreads - different strikes and different months
How do vertical spreads profit?
From a directional movement in price. Bullish spread can be formed by buying lower strike price and PM and selling higher price. Profit will be limited to higher strike price = premium.
Why would an investor purchase a horizontal spread?
Expected volatility to rise or fall
How you do you construct bull calls and bear calls?
Bull call - buy lower strike and sell upper strike - moderately bullish
Bear call - buy upper strike and sell lower strike - moderately bearish
How you would you construct a horizontal spread when volatility is expected to rise generally and in the short term term?
General rise - sell short dated and buy longer dated - shorter dated securities will fall faster as volatility increased
Short term rise - buy short dated and sell long dated
What would an investor use diagonal spreads?
They are directional.
How would an investor construct bullish and bearish diagonal spreads?
Constructed with call options if bullish
Constructed with put options if bearish
Why would a trader use straddles and strangles?
Attempts to profit from changes in volatility on the underlying assets.
How would a trader construct straddles?
Extremely bearish / bullish on volatility. Done by buying a put and call which means if price falls outisde the margins profit will be made.
What are the differences between a strangle and a straddle?
Purchase of put and call at different strike price in a strangle in straddle strike price is the same, just with directional put and call
PM outlay will usually be lower
What are the 3 long synthetic futures?
Long future - buy a call and sell a put
Long call - sell a call and buy a put
Long put - buy a call and sell a future
What are the 3 short synthetic futures?
Short future - sell a call and buy a put
Short call - sell a future and buy a put
Short put - sell a call and buy a future
How can investors indirectly access the derivatives market?
Through accounts managed by a regulated firm
Through Collective Investment Schemes and pooled funds
What are the 3 main types of derivatives investment styles?
Speculative
Guaranteed
Synthetics
What are CISs that primarily use derivatives called?
Hedge funds
What is a difference between AUTs and UUTs?
UUTs cannot be freely marketed to different customers.
How does the SEC Classify an indivual investor as opposed to a retail client?
