Less than four months into 2022, the US stock markets recorded its worst monthly performance since the dramatic stock market crash in early 2020 due to a COVID-19 outbreak. In particular, S&P500 was down about 8.8% while the Nasdaq Composite fell 13.3%. Still, the April Market weakness has investors concerned about the prospect of a much deeper market crash just around the corner (Forbes Advisor, 2022)

One of your long-term clients, Mr Liam Mason, constructed a stock portfolio on 21st June 2021 and intended to sell the portfolio on 6th May 2022. His portfolio consists of any four U.S. stocks (among nine stocks listed in Exhibit 1) plus NexTier Oilfield Solutions, Inc. (NEX) stock. With the intense market volatility and his biggest concerns revolving around inflation, and geopolitical tensions exacerbated by Russias invasion of Ukraine, Mr Liam worried that U.S stock market would fall deeper in the near future. However, assuming he was confident that the stocks in his portfolio would outperform the market. Therefore, on 3rd February 2022, he asked you to set up a hedge against his portfolios market risk using CME E-Mini S&P500 index futures. He expected the hedge to be in effect at the close of trading on 3rd February 2022. The futures contract prices are presented in Exhibit 2, while the contract size of all futures is $USD50 per index point.

This task aims to investigate how index futures can be used to reduce the market risk from holding the stock portfolio. In particular, you need to propose:

a) Which futures contract your client should use (i.e. June 2022, September 2022 or December 2022 E-Mini S&P500 index futures). Justify your choice.

b) The number of futures contracts for the hedge and report the position in futures contracts to be taken, in order to reduce the beta of Mr Liams stock portfolio to 0.2.

Exhibit 2: CME E-Mini S&P500 index futures price Futures Contract Price on 21st June 2021 4,188.5 CME E-MINI S&P 500 INDEX JUNE 2022 CME E-MINI S&P 500 INDEX SEP 2022 CME E-MINI S&P 500 INDEX DEC 2022 4,177.3 4,167.5 Price on 3rd February 2022 4,462.0 4,460.3 4,460.75 Price on 6th May 2022 4,119.5 4,123.0 4,135.75 Exhibit 2: CME E-Mini S&P500 index futures price Futures Contract Price on 21st June 2021 4,188.5 CME E-MINI S&P 500 INDEX JUNE 2022 CME E-MINI S&P 500 INDEX SEP 2022 CME E-MINI S&P 500 INDEX DEC 2022 4,177.3 4,167.5 Price on 3rd February 2022 4,462.0 4,460.3 4,460.75 Price on 6th May 2022 4,119.5 4,123.0 4,135.75