How to hedge an ETF when spot markets are closed
Good morning,
I came here looking for help and I think you might have the answer.
I am currently applying for a Trader position in a big firm, but I would be a Junior basically, I would be learning, although I have been trading on my own for a few years.
However, I have read that one of the questions on the interview process on my next step is something like "How can you hedge an ETF when https://9apps.ooo/ the spot markets are closed?" and I can not come to a good conclusion. I have a few options:
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If you want to hedge currency then you can use the Forex market so that foreign currency has no impact, but I do not think they are talking about currency.
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Using the futures market to short it?
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Someone said that their answer was "buying the underlyings" but I do not understand how that would hedge an ETF. If I have got an SP500 ETF how would I hedge by buying GOOGL, AMZN, FB, MSFT, etc... Profits would go in the same direction.
Thank you for your time.
If spot is closed then you can't buy underlying, so your hunch is correct, not #3. Directional risk is most important so its #2, but short futures isn't the only way you can do it-, fx risk is probably not what they're looking for but worth mentioning that you considered it
How else would you directly hedge against something like SPY besides futures if spot market is closed and therefore no options?
Options aren't part of the spot market - spot would be the underlying ETF shares (unless the ETF holds options then the whole premise doesn't work), so that would be it.
I also said 'short futures' aren't the only way; for something like SPY, you can also use futures on the inverse ETF to hedge directionally. Whether or not that's a better idea is beside the point
Depends on the ETF; if they're asking about one that tracks the index, commodity, etc. then you can easily hedge with futures, but I'm guessing they're asking if it's a more niche sector/strategy ETF to see your thought process. However, option #2 is the closest you can come to perfectly hedging directional risk, since SPY for example and /ES track the exact same underlying. The others would be approximations, as you would pretty much inverse the tradable market that drives the ETF in question the most. Although it would entirely depend on the ETF. For example, an ETF that tracked certain grain companies then it would make sense to hedge with that specific commodity since the correlation is pretty direct (changes in futures market affect share prices very fast). However, if it is a tech, real estate, etc. ETF, then you would probably hedge with a currency or interest rate product, but the problem with that is that changes in the share price will lag behind quite a bit, and at that point it would really make no sense to the question practically because why wouldn't the spot market be open? The only time I can think that this would happen in real life would be weekends. I guess if you suddenly needed to hedge a SPY long then you could sell /ES futures. Or if you were trading a crypto ETF/trust you could hedge with the underlying since they trade 24/7. Hope that helps. Basically just find a market that's open that a) not only drives the performance of the ETF the most and b) drives the performance quick enough (which is pretty much impossible outside of indices and their futures).
Two quick thoughts
1. Your idea to use futures is definitely valid, and I suspect the "right" answer
2. If it's an equity ETF, there may be international ADRs of at least some of the underlying holdings available to trade that would enable hedging.
There is a spot market open somewhere in the world. You indirectly hedge by trading in a different region.
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