Portfolio Hedging

[decipher]

Have been thinking of hedging portfolio systematically.

Gemini gave an idea of using 1-3% of portfolio on 1Y SPY puts (or alternate indexes) at .12 delta. Check monthly, harvest 50% of gains if delta slowly gets to .25 or .35 otherwise leave the hedge alone. During fast crashes, aggressively roll the puts lower (use 4x as the trigger). Similarly, roll the puts higher if delta falls to .05 during recoveries.

I believe 3% hedge comes from Nassim Taleb (author of black swan book). Thinking of using Shiller PE as guidance to adjust percentage of hedge between 1-3%.

Is this a viable hedge? Are there any other commonly used hedging strategies for small portfolios?

[coffeecaninvestor]

Not to be “that” guy who poo poos ideas like this..but it seems overly complicated and potentially expensive drag on returns.

 

why not just create a live that ensures your not a forced seller, and ride out volatility. 
 

I don’t think there is a silver bullet when it comes to trying to hedge or reduce down side volatility. Dollar cost averaging is probably you’re best hedge especially for a smaller portfolio, and trying to stay fully invested. 

[decipher]

I always held high cash percentage, 25-50+%. It helped in sideways and down markets. Over long run, returns suffered. 

 

If hedging with 1-2% allows me to be fully invested, I am guessing it will pay for itself.


 

[Red Lion]

38 minutes ago, decipher said:

I always held high cash percentage, 25-50+%. It helped in sideways and down markets. Over long run, returns suffered. 

 

If hedging with 1-2% allows me to be fully invested, I am guessing it will pay for itself.


 

If the puts usually expire worthless and you’re putting in 3%, that’s basically a 10% return on 30% cash. Where the cash itself earns about 3.5% right now. I doubt you come out ahead with this approach over the long run, unless you’re just marketing timing. 
 

if you are living on portfolio draws at 4%, how many years worth of cash do you really need? Especially if your stocks pay some dividends? Maybe 10-15% tops to avoid selling during a protracted down market. 
 

 

Edited 22 hours ago by Red Lion

[73 Reds]

5 hours ago, Red Lion said:

If the puts usually expire worthless and you’re putting in 3%, that’s basically a 10% return on 30% cash. Where the cash itself earns about 3.5% right now. I doubt you come out ahead with this approach over the long run, unless you’re just marketing timing. 
 

if you are living on portfolio draws at 4%, how many years worth of cash do you really need? Especially if your stocks pay some dividends? Maybe 10-15% tops to avoid selling during a protracted down market. 
 

 

Yep.  Anyone who feels the need to maintain 25-50% cash probably lacks confidence in their investment abilities.  My advice would be to follow Jack Bogle's advice and remain nearly fully invested & DCA into broad based equity index funds, less any cash that you need for day to day expenses and a sufficient cushion.  Hedging rarely works because you're typically over-hedged or under-hedged for any actual event.

[decipher]

@Red Lion You are right, 3% is excessive. 1% might work if the hedge can throw cash to be invested as market goes down.

"Maybe 10-15% tops to avoid selling during a protracted down market." - This sounds about right to ride out downturn.

@73 Reds DCA works well if downturns happen early in career. In my case, annual additions are getting small relative to portfolio. The critical thing seems to have enough cash cushion to avoid selling during multi-year down markets like 2000-2003.

A more general question - why would anyone hedge? Is it to manage short-term risks?
 

[73 Reds]

5 minutes ago, decipher said:

@Red Lion You are right, 3% is excessive. 1% might work if the hedge can throw cash to be invested as market goes down.

"Maybe 10-15% tops to avoid selling during a protracted down market." - This sounds about right to ride out downturn.

@73 Reds DCA works well if downturns happen early in career. In my case, annual additions are getting small relative to portfolio. The critical thing seems to have enough cash cushion to avoid selling during multi-year down markets like 2000-2003.

A more general question - why would anyone hedge? Is it to manage short-term risks?
 

Good question.  I'm old enough to have been through a number of downturns, beginning in Oct. 1987 (though admittedly didn't have much back then).  Never felt the need to hedge b/c always felt the asset mix was appropriate and had sufficient income coming in, which is probably the main point.

[scorpioncapital]

maybe hedge with assets uncorrelated. or avoid bubble sectors.

[frommi]

22 hours ago, decipher said:

I always held high cash percentage, 25-50+%. It helped in sideways and down markets. Over long run, returns suffered. 

 

If hedging with 1-2% allows me to be fully invested, I am guessing it will pay for itself.


 

Somehow yes. What most people forget about put options is that they can also print money, its not that every option will expire worthless. I hedge constantly especially during summer months and while the past 10 years it has dragged down returns, holding 40-50% cash would have been far worse. Over the past 10 years my hedging was a drag of roughly -2% per year, and most of my hedging is buying a 5%(of portfolio) put position on the DAX in april (5% OOM, 5xprofit target, december expiration) and hold it too the end of october. And we didnt have a down year in summer the past 8 years, so i think -2% is very acceptable, 1 year of reaching the profit target will still be enough to wipe out all losses and give me cash when stocks are dirt cheap. It also reduces drawdowns much better than a large cash position, because even with 50% cash you will have material losses in case of a crash.

The excess return podcast has an option guy, that advises to buy put options 4-6 weeks out when https://www.investing.com/indices/cboe-1month-implied-correlation is below 8. This is the price of a hedge, and at the moment its dirt cheap because nobody is afraid of a crash. Thats when you should be fearful, at least if history is any guide. For these shorter term options i would only buy 0.5-1% of the portfolio otherwise it can be costly over the long term, because options lose the most of their premium in the last 4-5 weeks. This is my plan for the winter months now, lets see how this plays out.

I can't hold cash, its just not in my DNA