Estimating Capital for a Market-Neutral Long–Short Strategy
Summary
The document considers the capital needed to simulate a daily long–short strategy that shorts the top five gainers and buys the top five losers, allocating $200,000 to each stock. The apparent offset between the $1 million long and short sides does not eliminate the need to fund the positions or meet broker margin requirements.
The response frames required capital in terms of margin: under its illustrative assumption of 25% margin on the $1 million short position, the account would need $250,000. Short positions are marked to market, so rising prices can trigger a margin call. This is a simplified estimate that excludes trading costs and relies on the stated margin assumption; it does not establish that the stock-selection rule is profitable or risk-free. The document also raises how to calculate returns when a strategy begins without capital, but does not resolve that question.
Key ideas
- A dollar-neutral long–short position still requires capital to satisfy margin requirements.
- The example estimates $250,000 of account equity for a $1 million short position at 25% margin.
- Short positions are marked to market, and adverse price moves can lead to a margin call.
- The estimate excludes trading costs and depends on the assumed margin rate.
Tags
Full text
# How Much Capital is Needed to Start an Arbitrage Strategy? # How Much Capital is Needed to Start an Arbitrage Strategy? I'm trying to experiment with a simulated simple arbitrage strategy. I'm not doing this to actually invest, I'm just curious if the market is inefficient enough for this to be feasible. Every morning, I take the top 5 gainers and losers as per Google Finance, then record in excel what my balance would be if I shorted the gainers and bought the losers. My "trades" are each for $200,000 worth of stock. Because I am going both long and short 1 million dollars, on paper It looks like my shorts pay for my longs and I only have to pay for trade fees and whatever the loss might be at the end of the day. How much capital would you actually need to do this? Nobody would just let you start shorting stocks to raise money (I think), so how much would you need to run this strategy? If you start with 0 dollars, any returns would leave you with an infinite growth rate. How else could you calculate return? ## Answer by Luke (score 3, accepted) https://quant.stackexchange.com/a/12866 Excluding trade costs (which is a big assumption), you would need to consider margin.. http://www.finra.org/Investors/smartInvesting/AdvancedInvesting/MarginInformation/p005922 Assuming 1MM Short with 25% margin, you would need 250K in a margin account. This would be marked to market and you might get a margin call if your shorts climb.
Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.