Pricing Futures

In: Business and Management

Submitted By stvnclmn
Words 2177
Pages 9
Abstract
This assignment is divided into two parts. Part 1 aims to construct a hedging strategy using index futures through a simple regression, with the change in spot price as the dependent variable and the change in futures price as the independent variable. We have used historical prices of the S&P 500 index and its index futures. Hypothetical examples of how to utilise the optimal hedging ratio obtained from the regression were also discussed. Part 2 explores various option trading strategies using options of three firms listed on NASDAQ:  News Corporation (NWS), market capitalisation: $ 13,208 million Seagate Technology (STX), market capitalisation: $ 5,109 million  Titan Machinery (TITN), market capitalisation: $ 482 million In part 2.1, we have constructed various speculative positions on these stocks on 19/09/2011 based on recent news as well as our expectations of their future stock price movements. Profit and loss were calculated on 26/09/2011 and again on 03/10/2011. In part 2.2, we used options from these stocks to construct various commonly used combination strategies on 22/09/2011 and calculated profit and loss on 29/10/2011.

1

Hedging with Futures

Assuming that we are holding an S&P 500 index portfolio and we have a long position in the underlying asset. In order to hedge our exposure, we must take a short position in index futures. Our investment horizon is three years, thus we will be using three years of data from the period 2008-2010 in our regression to calculate the optimal hedge ratio. We performed a regression of the change in spot price on the change in futures price, and the coefficient gives us the optimal hedge ratio, which in our case is 0.9825. A hedge using this ratio would give a near-perfect hedge, as the R2 from the regression is 0.9603. Please refer to Appendix A for the details of the regression output. The size of an…...

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