Scenario:

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 largest stocks listed at ASX: CBA, CSL, BHP, WBC, 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. At the same time, your client is also interested in index derivatives and wants to explore the investment opportunity in this type of products.

Rather than be used as a tool of risk management (i.e., used to remove market risk in an equity portfolio), Index futures can also be used in different ways and play a very import role in investment opportunities. There are two basic strategies that can be used by large traders, i.e., buying futures instead of buying stocks; selling futures instead of selling stocks. When one has money to invest in buying stocks, it might make more sense to buy Treasury bonds and futures instead of buying stocks to gain profit. Also, there are general relationships between many stock indexes. The arbitrage opportunities arise whenever the relationship between two indices is out of line. The idea behind "index spreading" is to capitalise on one's view of the relationship between the two indices without having to actually predict the direction of the stock market.

Question 1 (Speculation and Arbitrage using Index futures):

Based on the above, research and show your client how to explore investment opportunities by using index derivatives if the client did not own any shares but have $1.5 million to invest in derivatives. In the document that you are going to provide to your client, you need address strategies as well as a brief discussion on return and risk analysis for each possible strategy.

• Note: Precisely speaking any strategy is unavoidably including personal judgement about market. If you have to classify strategies by trading motivations, it could be a speculation, it could be an arbitrage. As such your discussion should include all possibilities that, in your view, your client can use.