Hi all. Long time surfer, first time poster.
I am pretty good at the equations and quant across the materials but am having trouble understanding why portfolio managers do certain things. This question is about Schweser 37.e.
Can someone explain why I would want to delta hedge (own shares + short calls) to earn the risk free rate? Wouldn’t it be easier to buy a treasury?
Keep up the good work everyone, good luck studying.
Thanks.
you already own the stocks , you don’t want to incur transaction costs selling them , but you think they have poor short term prospects.
in addition to transaction cost there could be tax reasons
tax is a highly nuanced subject . under the wrong conditions using options to hedge could be labeled constructive sale
I like the tax reasons. I would assume rebalancing daily to be delta neutral would incur greater transaction costs selling off the stock and buying treasuries.
Not if you’re a founder that owns 20% of float, or an activist investor that wants to retain voting rights, etc.
I assumed you would only do it for a limited time if you thought it would underperform.
Very nice responses. Thanks all.
i agree with janakisri. The primary reason would not be tax (as tax would increase due to the constant rebalancing) but the belief that what you currently own will underperform the Rf in the short term and you do not want to liquidate because there are restrictions (illiquidity/required holdings periods/work at the company)
It is because you feel that stock will under perform temporarily but you still want to maintain long position in the long run.
Hence, one alternative is to use derivatives (options) to convert equity exposure to risk free for the time being.
Futhermore, this is a cheaper alternative as compared to selling stocks and buy bond that will incur transaction costs and tax implication.
Another reason could be portfolio manager has restriction imposed by IPS to maintain certain target allocation.