Question

Overview:

describe your hypotheses and trades in detail?;

Futures and exchange-traded options are widely available for the following asset classes:

Equities

Energy

For each of these asset classes, please develop a well-reasoned hypothesis regarding the relative performance of two assets within the asset class. A relative performance trade (otherwise known as a pairs trade) does not require you to identify whether a given security will increase or decrease or value. Instead, it requires the following:

1. Identify two assets within the asset class.

2. Identify which of the two assets you believe will outperform the other asset.

3. Long the asset that you believe will outperform and short the asset that you believe will underperform.

Relative performance trade example

Here is an example of a relative performance trade.

Imagine you are forming a relative performance hypothesis related to the following two stocks in the apparel stores industry:

Gap, Inc.

TJX Companies

You do not know whether the overall stock market will increase in value or decrease in value in the future. But you do believe that whether markets increase or decrease in value, GAP, Inc. will outperform TJX Companies. Therefore, you should long Gap, Inc. and short TJX Companies. If you do so:

- If markets increase in value, your long position in Gap, Inc. will increase in value more than your short position in TJX Companies will decrease in value.

- If markets decrease in value, your long position in Gap, Inc. will lose less money than your short position in TJX Companies will earn in value.

For each hypothesis, please develop an exchange-traded derivatives trade that can monetize the view. Hence, derivatives that do not trade on exchanges, such as forwards, credit default swaps, or interest rate swaps, should not be used. Only use derivatives – do not use any cash products such as stocks or bonds.

Please assume that you have up to $1,000,000 to allocate to each strategy

Please assume that you will acquire the position sometime during this week June 9, 2018, and will hold it until July 2018

Answer 1

We are developing a relative performance hypothesis related to the following two stocks in the Energy industry:

1. Exxon Mobil Corp. (XOM)

2. US based Williams' companies

Irrespective of how the overall stock market will perform in future but that whether markets increase or decrease in value, Exxon Mobil Corp. will outperform Williams' Companies referring to the historical data of performance. Therefore, it is advisable to take a long position on Exxon Mobil and take a short position on Williams' Companies.

The results could be:

- If markets increase in value, long position in Exon Mobil will increase in value more than short position in Williams' Companies which will decrease in value.

- If markets decrease in value, long position in Exon Mobil will lose less money than your short position in Williams' Companies will earn profit.

Assuming an investment of $1,000,000 in each long and short position strategy, we will enter derivatives market as below:

	When market increases
	Short - William's co	Sell call = expecting the price to decrease
	Total investment	10,00,000
	Call price	20
	No of put units	1000000/ 20 =	50,000
	Premium paid = 20% of total investment =	1000000*20% =	2,00,000
Date 30 July 2018	Strike Price	20
Date 30 July 2018	Spot price	25
	Loss	20-25 =	5
	In case of loss option is not excercised and loss is equal to the premium paid
	Total loss	2,00,000
	Long - EXON Mobil	Buy call = expecting the price to increase
	Total investment	10,00,000
	Call price	85
	No of call units	1000000/ 85 =	11,765
	Premium paid = 20% of total investment =	1000000*20% =	2,00,000
Date 30 July 2018	Strike Price	85
Date 30 July 2018	Spot price	100
	Profit	100-85 =	15
	Total loss = No of put units *Profit	1,76,471