The US equity market has been crazy. I don't think it is the right time to either long or short the market as it is so unpredictable. It could go up. It could go down. I should liquidate all my positions and just keep cash.

Dan:    I am afraid you are wrong again.

You:    Do explain.

Dan:    Well, there are always trading opportunities, especially true in this high volatility period. Why don't you sell some spreads?

You:    Selling spreads?

Dan:    Yes, like... selling some spreads using options. I thought Frank has covered in that on Wednesdays?

You:    Let me think about this. It has been a while since I watched his lecture recording.

Given the market condition described in their conversation, please discuss what spreads Daniel may refer as the correct trading strategies. Please also discuss what trading strategies may be better, and why they are better, if "you" believe the market is more likely to go down by a lot.

 

You are the president of the UWA Risk Management Club. You recently got involved in a consulting task from a local resource company, Perthermo Green Coal (PGC). PGC is considering taking a few positions in ICE Newcastle Coal February 2023 futures contracts (with an expiration date on 24 February 2023). Their expected delivery date to clients in China is 30 January 2023.

The CEO of PGC has sent you a list of questions before the first formal meeting. Worrying about losing the consulting task to other elite clubs such as SMIF, QFIN and FAWA, you decide to review what you learnt in FINA2204. The list of questions is included below:

Q1: Shall we long or short the futures?

Q2: Why can't we stick with ICE Newcastle Coal January 2023 futures contracts?

Q3: If we close our position as soon as the futures price is equal to the underlying spot price, does that mean our hedge is a perfect hedge?

Answer rating: 100% (QA)

Lets start by discussing the trading strategies that Dan may be referring to as selling spreads using options In a high volatility market traders often employ options strategies to manage risk and tak... View the full answer