LENGTH: 30 minutes - 1 hour

LEVEL: Beginner to Advanced

Learning Objective:
Students will learn how to hedge by taking on different positions in similar companies. Students will also learn about correlation.

Instructions:
Your assignment is to create a portfolio of stocks in a single industry. You should have somewhat of a general view on the industry’s performance in general for a period of x weeks (ie, I think Energy will do well in the near future). 

Because you are constrained to just one industry, the only tool you will have to mitigate risk is having both short and long positions. For example, if you think Technology will perform well, even though your portfolio will include both short and long positions, your portfolio should be relatively long (ie 60% long, 40% short).

To start off, navigate to the left side bar and click on the Trade > Stocks tab. Using the industry filter, select one of the following industries:

  • Energy
  • Financials
  • Healthcare
  • Technology

Then, create a portfolio with 10 stocks total (5 long positions, 5 short positions — see how to create a portfolio for details). For each long position, you should have a short position as a direct hedge (or vice versa). Ideally, you’d hedge each of your positions with similar companies. 

For example, if you think Google and Facebook will be affected similarly by future events and respond similarly, then it may be a good idea to short Facebook and long Google. You will monitor this portfolio’s performance for x weeks.

After you have created your portfolio, write a couple of paragraphs explaining what your view on the selected industry is, how you expect the stocks to perform relative to one another (correlation), and how aggressively you decided to hedge your position and why (ie. elaborate on why you’re short Financials in general and long 25% of your portfolio).

Also, make note of the following ETFs current price, depending on what industry you selected (you will compare your portfolio's performance to the ETF’s at the end of the exercise):

  • Energy: XLE
  • Financials: XLF
  • Healthcare: XLV
  • Technology: XLK

At the end of the exercise, write a paragraph assessing your portfolio’s performance. Your reflection should include the relative performance of your long vs your short positions, as well as the overall performance of your portfolio compared to the industry ETF. Make sure to include snapshots of the portfolio performance graph, the portfolio’s long vs short distribution, the portfolio’s holdings table, and any other information you think is relevant. 

Also make sure to address the following questions: 

  1. Did your portfolio perform as you anticipated it would? 
  2. What went as you expected? Was there anything that was unexpected? 
  3. Did you hedge too aggressively? Did you not hedge aggressively enough? 
  4. Were you right about the correlation between your long and short positions? Did stocks you think would perform similarly in fact perform similarly? 

Deliverables: 

  1. Industry view and portfolio strategy document at beginning of exercise.
  2. Reflection at end of exercise (including performance report downloaded from EquitySim website).

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