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Let us say I am long SPY and I sell the corresponding number of e mini s&p futures. Now, how will this portfolio profit?

Will this grow at the risk free rate? The profit from the stock position is cancelled by the loss from futures position. So how will it profit?

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Your example isn't truly a wash since the SPY is not the same as buying the contract being sold as you cannot fulfill the EP with the SPY. Nonetheless what you're suggesting is that you are long the commodity and short the future. This is what's called cash and carry arbitrage, and your profit will simply be the market time value of money for the perceived risk. Consider the same trade in gold. You take delivery of the contract and short the future next year... You must pay to store the gold and bear the margin between now and the date of future delivery but you will likely have some non-zero return.

This is not inherently a risk free rate, as you must be compensated for carrying unlimited risk for the shorts. However, this rate might by less than you could make in other similar investments.

A hedged portfolio doesn't seek to 100% balance a position. A hedged portfolio seeks to track the benchmark's performance with less risk than the benchmark.

  • So this is my confusion:"A hedged portfolio seeks to track the benchmark's performance with less risk than the benchmark." you are reducing profit potential at the same time as you are reducing risk. So how can you track the benchmark performance if you have sold the future? The underlying will track the benchmark but the future will offset the gains from the underlying. – Victor123 Mar 30 '15 at 14:15
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    Your example is oversimplified. A portfolio using the SP as a benchmark would likely have different investments in it than the SP. – Matthew Mar 30 '15 at 16:41

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