About the post yesterday...I don't want to pretend I'm an expert about how hedge funds use correlation etc to carefully manage their risk, but I imagine that it works like this....
If a Hedge Fund wishes to make money they can use mathematics to determine what exposures they should take on both sides of a well correlated pair of asset classes to almost guarantee positive returns. For instance yesterday they decide to sell LTR (and maybe other lithium stocks) based on an estimated return from reinvesting the proceeds into lithium futures contracts. So they are short LTR but long lithium futures with say a November contract date. The correlation will not be 100% but they may calculate that it is 85%. Then for every point change in each asset they know what profit/loss they will make.
That calculation is put through their models and they can establish a modelled outcome based upon all their collective exposures, and these days with very powerful laptops even, recalculate in real time what their position is. In my opinion this is a quite closely managed exercise that will be profitable in most circumstances. Their biggest risks are things like takeovers or black swan style events the cannot be predicted and do not permit managed exits. they will likely also be using montecarlo simulation to determine a range of possible outcomes with probabilities attached. That helps in decision making.
I just thought I would try to put before forum members my take on short selling etc and it's link to the use of futures. I'm happy to be called out if I'm nowhere near the mark.
regards
DF
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