This part is to look at index futures and a strategy called “portfolio insurance” which is accused of causing “Black Monday:the stock market crash of 1987”.

To make the questions more vivid, let’s assume you are a financial consultant and one of your client is holding an equity portfolio. The value of the portfolio is $1.5 million currently and investing equally in the following 15 stocks listed at ASX: CBA, BHP, AGL, SEK, NAB, WES, ANZ, FMG, WOW, MQG, TLS, RIO, TCL, GMG, and COL. Your client is worried about the market risk in the next 6 months and seeking advice from you.

After discuss the concern of your client, you recommend to use Index futures to do the hedge. Please explain to your client what is the logic behind hedging a portfolio with an index futures? or Equivalently, what is the reason for hedging a portfolio with an index futures? After giving the general idea about the hedge, based on your client’s situation, please further to show your client your strategy or your plan. Your strategy needs address, but not limited to, the following questions: 

(1) when you need to choose a futures contract, what underlyings you need to use? What is the reasoning/consideration behind your choice? 

(2) Which maturity you need to choose? What is the reasoning/consideration behind your decision? 

(3) What are the important information you need to collect in order to determine how many contracts you need?