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Hedging


Packer16
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I know many on this board used options to hedge exposure to the fall in the market in 2008.  What did you use and what was most effective?  Did the strategy yield a net positive return over the period it was used or was it a net drag on performance?  I got hit hard in 2008 and was contemplating buying some insurance.  TIA.

 

Packer

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In the spirit of the Xmas season.

 

Keep in mind that options, futures, index instruments were invented for use by portfolio managers because they typically cannot hold any significant cash (I dont pay a PM to hold cash), and cannot buy/sell the underlying instrument without moving the market. As a retail client you do not have these restrictions.

 

Because you could be wrong, the 'true' hedge is to sell 1/2 the existing position. If you're wrong the additional cost to repurchase is your hedge cost, & you largely control it as its your decision as to when to repurchase. If you're right you'll have a cash gain & a lower cost base.

 

The optimal hedge against loss is to sell the entire existing position & write out of the money puts that you want to get exercized. If successfull you'll have a short gain AND get paid for your liquidity, but its a directional hedge - so if you're wrong you'll have a loss.

 

Know why & what you're really hedging. As options, futures, etc. have embedded leverage (ie: risk), why is that important to you for hedging purposes ?

 

There is nothing wrong with options or futures use as 'entertainment', but know it before you try it.

 

Merry Xmas

 

SD

 

 

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Hi Packer,  Going into the Fall of 2008 I was holding puts on the SPY tracking stock.  I sold most of them out at a profit in the 1150-1250 S&P range.  Obviously, I missed the biggest gains and the best effects of the hedging.  However, I would have done the same thing again since I cannot answer the "when to sell problem".  In the end the biggest gains I got last year came from selling stuff daily on the way down in February, and buying other unrelated stock as the same time.  By doing this I have captured a tax loss and all my gains into the rest of the year are protected by the huge losses I took.  I am up substantially on the year using January 1st to today. 

 

Right now I hold a small amount of the same SPY puts as partial insurance, which I bought in the last month.  This is to shield me from having to take any taxable gains before the New Year.  Unless markets drop dramatically I will let these lapse and take the loss.  That is a true hedge. 

 

Otherwise I tend to agree with Sharper.  It becomes a balancing act of opportunity costs.  When in doubt 'keep it simple' probably applies which means holding cash until more compelling opportunities arise. 

 

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