Hedging Away the Market

A market neutral return calculator models the classic long/short trade: buy a high-conviction long book, sell short a comparable book, and size the short leg so the combined portfolio's beta collapses toward zero. What remains is pure stock-selection spread.

The Hedge Ratio

If the long book has a beta of 1.1 and the short book 1.05, you need 1.1/1.05 ≈ 1.048 dollars of short exposure per dollar of long exposure to neutralize market risk. The strategy return is then the long return minus the hedge-ratio-weighted short return.

Alpha and Interpretation

With beta near zero, the strategy's return should be compared against the risk-free rate rather than the market. The gap is alpha: if it is consistently positive, the manager is adding value through security selection rather than riding a bull market.