Hedge fund strategies: Long short 2

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Hedge fund strategies: Long short 2발음듣기

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In my attempt to have a portfolio whose performance should depend only on my ability to identify good companies and to identify bad companies and not be held sway by whatever the market might do I have bought a share of company B thinking that it's a pretty good company that'll do better than expected.발음듣기

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And I shorted two shares of company A and I shorted two of them because they're only 5 dollars a share and I wanted to short the same dollar amount.발음듣기

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So now I want to think about, assuming that I was right.발음듣기

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That company B will do better than company A relative to each other How my investment will do if the stock market moves up or if the stock market moves down?발음듣기

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So let's imagine a situation where the stock market moves up.발음듣기

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And that situation you can imagine both of these stocks will go up.발음듣기

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So let's say company B goes up in percentage terms more than Company A.발음듣기

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So let's say that company B gets to 15 dollars.발음듣기

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So it gets to 15 dollars a share so it is up 50%.발음듣기

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And let's say that company A only goes up by 20% so it goes to 6 dollars a share.발음듣기

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So company A only goes up by 20%.발음듣기

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Up 20%. So it is now up to 6 dollars a share.발음듣기

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So in that situation what happened? I clearly make a lot of money on company B on my long position when the stock market goes up and 10 dollars became 15 dollars so I made 5 dollars there And I clearly lost money on my short position.발음듣기

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Because I sold it at 5 and now I'm going to have to buy it back at 6.발음듣기

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If I want to cover my short position.발음듣기

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So this 10 dollar position remember I have 2 of shares of them, are now worth 12 dollars are now worth 12 dollars. 2 times 6 dollars.발음듣기

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And since this is a short postion I will lose 2 dollars But because the company that I thought would do better did do better it went up by more; It went up by 50 percent while this only went up by 20 percent I still make money.발음듣기

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I still make a 3 dollar profit.발음듣기

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Now let's think about what happens if the whole stock market goes down.발음듣기

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And I'm going to assume that I'm good at picking the right companies so I assume that my thesis holds: that B does better relative to A.발음듣기

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So let's say in this negative scenario B goes down by 20 percent So let's say B goes down by 20% So down by 20 percent So it gets to 8 dollars a share.발음듣기

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It gets to 8 dollars a share So this is the market up scenario.발음듣기

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Now let's imagine the market down scenario Market down.발음듣기

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So now my position in B goes from 10 dollars to 8 eight dollars so I lose 2 dollars on my long position But when the market went down, I was right, A is not that great of a company so it goes down more.발음듣기

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Let's imagine that it goes down by 50 percent.발음듣기

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So A goes down by 50 percent. Down by 50 percent.발음듣기

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All the way to 2.50 per share.발음듣기

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So now it's at 2.50 per share.발음듣기

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So my position in A the short position that was 10 dollars It is now a 5 dollar short position. 2 shares at 2.50 per share.발음듣기

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So this is a short position I sold the stock that I borrowed and sold it at 10 now I can buy it back at 5, I make 5 dollars on the short position when the market goes down.발음듣기

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So even though I lost some money on my long position when the market goes down I more than make up for it on my short position.발음듣기

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So even in the down market, assuming my stock picking is good, I have still made, I have still made 3 dollars.발음듣기

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And so what we've set up here is the long-short hedge and what's cool about it is it's only dependent on the investor's hability to differentiate the companies that are more or less likely to do well relative to other companies.발음듣기

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And it's not as dependent on someone's ability to pick which direction the market itself will be going.발음듣기

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And so when people talk about long-short hedge funds they're talking about hedge funds that are essentially doing this They're trying to hedge out the market risk.발음듣기

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