Question

If an investor strongly believes that the stock market is going to have a sharp decline shortly, he or she could maximize profit by a. short selling stock-index futures contracts. b. hedging current short positions. c. using stock-index futures to straddle the market. d. buying stock-index futures contracts.

Answer 1

The correct explanation is option (a), "short selling stock-index futures contracts".

What is short selling stock-index futures contracts?

When you buy a futures contract to "short sell," you are doing so with the intention of selling it later at a lower (ideally) price. Unlike the stock market, there is no requirement for financing.

The working of short selling stock-index future contracts is-

• The concept is to obtain anything you don't already own on loan, sell it, and then return it.
• Even though you will now receive the funds, you still owe the money you borrowed.
• You eventually have to return it.
• You make money if you can later purchase it for a lower price.

The future contract can be shorted by-

• By locking in a price through the directional hedge known as shorting the basis, any asset price changes are effectively eliminated until the futures contract expires.
• When shorting the basis, a long hedger prefers a narrowing in the basis.

To know more about the futures in contract, here

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