1992issue C011-4
Portfolio beta overlays with index futures and puts
Systematic exposure can be reset without rotating the stock book. Size cash-settled index futures to a target portfolio beta, then decide whether a protective put should bound that same overlay so the underlying holdings can stay intact.
- Systematic risk is adjusted by changing portfolio beta, using new instruments or weight changes rather than physically rotating the entire stock book.
- A long stock-index futures overlay raises market exposure by the contract settlement value and reduces cash by initial and maintenance margin; a short overlay reduces stock exposure by that same settlement value.
- The futures overlay can be put on before replacement holdings are chosen, which separates a market-timing stance from security selection.
- A protective put on index futures is exercised only when the futures price falls below the strike, at which point it behaves like a short futures position; otherwise its effect is limited to the premium.
Change beta without rotating the book
Systematic risk is adjusted by changing portfolio beta. That can be done by introducing new instruments or by altering existing weights, rather than by physically rotating the entire stock book.
Portfolio beta is the value-weighted average of asset betas. It is the construction handle for systematic, or market, risk. Cash is treated as having a beta of zero in that average.
Beta hedging in this workflow means adding or shorting stock-index futures so the weighted portfolio beta moves to a chosen target without selling the underlying holdings.
Size the futures overlay
A long stock-index futures overlay raises market exposure by the contract settlement value and reduces cash by initial and maintenance margin. A short overlay reduces stock exposure by that same settlement value.
Futures contract selection is the choice of how many cash-settled stock-index contracts to buy or sell. The count comes from the target-minus-current beta gap, each contract's settlement value, and the cash needed for margin.
Because the futures overlay can be put on before replacement holdings are chosen, a construction desk can separate a market-timing stance from security selection.
A supplied contract count
In the supplied sizing example, lifting a 10000000-unit book from beta 1.2 to 1.4, with each index futures contract worth 150000 (300 times a 500 multiplier), requires buying 13 contracts after rounding 13.33.
Bound the same exposure with a put
A protective put buys a put on the index or on a single name so downside is used only if price falls through the strike. Otherwise the overlay's effect is limited to the premium already paid.
A protective put on index futures is exercised only when the futures price falls below the strike, at which point it behaves like a short futures position. Otherwise its effect is limited to the premium.
This is an asymmetric overlay. An option position changes beta only when exercise is in the buyer's interest, unlike a futures overlay that shifts exposure symmetrically.
A long call on index futures raises portfolio beta only if it is exercised when the futures price is above the strike. If it expires unused, the only portfolio effect is the premium paid.
Systematic and unsystematic overlays
Index futures and options target systematic risk. Listed options on single names can raise or lower unsystematic exposure by buying calls or buying puts.
All readings on this track · 13 readings
- 1989Rank rotation opens the names; pairing keeps the hedge
- 1991Evaluating allocation sleeves against an index proxy
- 1991Construct an equity book by weakening residual co-movement, then setting a market slope
- 1992Sizing index futures to retarget portfolio beta
- 1992Portfolio beta overlays with index futures and puts
- 1997Construct a trailing stop from beta and price
- 1998An offense-defense matrix for regime-aware stock selection
- 1998Constructing a stock-book duration proxy from beta and bond markets
- 2007An index put as deductible insurance for an active stock book
- 2010Constructing option overlays for beta-adjusted portfolios
- 2014Long-only relative value with an index hedge and a crisis stop
- 2017Hedging a rising book with beta and ATR
- 2019Sizing micro index futures overlays for cash equity books