A (HF) hedge fund, BigBets currently holds a well diversified (passive) portfolio of stocks worth Vp = $10m with p =1.2 (with respect to the

A (HF) hedge fund, “BigBets” currently holds a well diversified (passive) portfolio of stocks worth Vp = $10m with βp =1.2 (with respect to the market index the S&P500, which currently is at S=1000).

In addition, the HF holds VB =$1m in Boeing stock, with a current price of SB = $100 and a beta βB = 2. The risk-free interest rate = 1% pa (continuously compounded). The volatility of Boeing stock is currently 30% pa.

Derivatives contracts available include a 1-year futures contract on Boeing stock, a 1-year stock index futures contract and calls and puts on Boeing stock, with 1 month to maturity. (Assume Boeing stock pays no dividends).

The HF believes that over the next month, the market index (S&P500) will decrease by 2% (due to a slowdown in the world economy). The HF also believes that there will be a clear announcement about the grounded Boeing 737-800 jet in 1 months time, which will result either in the plane not coming into service (for the foreseeable future) or, it is announced that all the technical problems have been solved. The HF therefore forecasts either a 20% rise or a 20% fall (with equal probability) in Boeing’s stock price, depending on the outcome.

The boss of the HF states that you cannot change the composition of your stocks’ portfolio but you can use futures and options contracts to achieve the best outcome possible, for the HF over the next month, given the above scenario.  

Explain ONE strategy you might use (with futures and/or options) and the potential outcomes from your strategy. Explain any costs and risks in your strategy.