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CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses

A portfolio manager holds a diversified equity portfolio and expects a short-term market decline but wants to avoid selling the securities and incurring transaction costs. Which of the following actions is the most appropriate use of derivatives?

Selling equity index futures is the most appropriate action. The short futures position gains as the market falls, offsetting losses on the diversified portfolio, while the manager keeps the securities and avoids the transaction costs of selling them. Buying futures would add exposure instead of reducing it.

  1. ABuy equity index futures contracts
  2. BSell equity index futures contractsCorrect
  3. CWrite call options on a single stock

Explanation

Selling index futures creates a short position that gains when the market falls, offsetting losses on the held portfolio, with no need to sell the underlying securities. Buying futures would increase exposure to the decline. Writing calls on one stock gives only limited, stock-specific protection (the premium received).

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