Hedging An Appreciated Portfolio

[spindr0]

What I mean by paying to hold a collar (even a no cost collar) is that as price moves up on the underlying assets and away from your put strike. ?.

If the SPX approached the short call strike, one could roll the collar up. How much that cost would depend on how close it was to expiration. I think that it would be minor, compared to locking in another 5% of portfolio gain. That's the trade off. The ET option trader's wet dream is that after doing so, the market collapses and in additon to the ~5% put protection from the collar, that previous, near worthless set of puts also comes into play and the downside becomes a winner since you have double the protection, at least below the lower put strike. Yeh, unlikely but a nice fantasy that occasionally come true when near worthless long options come back to life.

As for shorting calls on stocks while buying puts on index, couldn't you get level 4 and do "naked" calls in one account backed by the stocks in the managed account?.

I have Level 4 so naked calls isn't a problem. I just wonder if that approach introduces the issue of stock specific news creating an additional problem, namely one stock zooms up, say due to a very good earnings announcement, yet the portfolio goes up minimally. Now I have a call loss without the associated 5% portfolio appreciation (my initial tentative collar distance premise).

I think the answer here is a blend of all of the above. But you'd basically need to have the exit strategy in stone from jump.

If I utilied an index collar. I think the management would be reasonably similar to what I do when defending or booking gains with a single equity and attached options (or a vertical). To the downside, get outta Dodge or roll the long puts down and sell more call premium if defending. To the upside, roll the entire collar up. I think increased vols would not be much of an issue to the upside.

For example, I have seen great results on the VIX ratio spreads, but I've given a lot back trying to figure them out. I just rest orders to sell when they hit a certain threshold now, and would have been ragingly profitable had I started like that--but as of now, it's running a loss. I'm also not sure how large of the VIX ratios I'd be comfortable with.

When you figure it out, post a Cliff Notes version here for me.

 

[ajacobson]

OK the devil is in the details and with more details the answer changes.

I would still match of some profits and losses in taxable accounts.

I assume the annuity has a minimum guaranteed return - if so than the annuity has some hedging already going on in it. I also assume it is indexed to some broad benchmark and some return parameters. Say X% of the bench-marked index or X% of the average monthly returns. Many annuities are crafted with a combination of some interest return instrument and then some structured options to create the upside. The ones sold with average monthly returns -for what it's worth - are not as peachy as they sound. Your return in an up year may be less than the annual return. Knowing more about the annuity will help you decide.

You mention some of the account is managed by a MM. Do you have any sense as to MM's ability to hedge? You don't want to double hedge and if the MM has the ability to change the asset mix and take some/all of the account to cash - hedging cash is unnecessary or certainly not a collar. The risk of cash is an upside spike.

Hedging needs a sense as to what concerns you - not clairvoyance and no one brings clairvoyance to the party. The key to getting rich has a component of "not getting poor" first.

What keeps you up nights? A flat year - a 10% correction - a brief flash crash - a protracted bear market - just to name a few, but what keeps you up nights?

What would you do with the payoff from a successful hedge? Just pocket it - bottom fish - buy some t bills?

Hedging is creating a form of insurance and some people want to be protected against a scratch in the parking lot - low deductible and expensive - or a catastrophic accident - high deductible,but much cheaper.

It sounds less and less like your a collar candidate and more like some ratio put spread. It would magnify small loss - not impact your upside - and create catastrophe insurance.

As I mentioned in my initial post it might be some put spreads and some collars.

How do feel about the upside. If we melt up in a week and you don't get the opportunity to roll are you going to hate yourself.

You don't need to post your answers - just think about your choices.

 

[spindr0]

Though I don't need to post my answers, I will because you have been providing the most thought provoking replies.

In hindsight, it would have been easier for everyone to follow had I provided more details - I was trying to keep it simple. I started with VA's 15 years ago and have 1035-ed a few times as well as having gone to cash with them in late 2007 (one VA transitioned to fixed via their market algorithm and I did the same with the other two). I fully understand and accept the rider fee drawbacks as a trade off for income for life. In 2009 I went back into one of them (market exposure) and I'm now drawing on the other two.

The one in question has a guaranteed 10% growth a year (simple) for 10 years on the deferred side with a guarantee of 5% a year withdrawal feature for life as well as 100% of the balance of PV after withdrawals if I die before 20 years. The sub account (portfolio side) has no indexing or guarantees. If the market is up, I'm up though I lag it due to the fees. Its value is almost a double now and is mine at any time, subject to taxation of gain. It has kept up with the deferred side and I'm in year nine. The 10 year deferred side has a year plus to run. Due to trading gains made in 2008-2009, my need for this particular income is no longer the issue so I'm more concerned with protecting current liquidation value, hence this hedging topic.

If I low/no cost hedge this with a 5% collar, it may allow me to avoid no more than a 5% loss (an approximate correlation assumption) and less if the puts aren't driven to parity after an ITM drop. If it challenges the upside, I can roll the collar up, locking in another 5% of gain while booking the loss on the ITM amount. If so inclined, I can liquidate a small portion of the VA to offset short call losses if they're significant.

Does this game plan make sense, give or take?

 

[ironchef]

If it challenges the upside, I can roll the collar up, locking in another 5% of gain while booking the loss on the ITM amount.

Rolling a short call up when challenged generally did not work too well for me, costed too much. Even if I rolled up and out to buy time and collect theta, they generally did not work too well either.

 

[newwurldmn]

Though I don't need to post my answers, I will because you have been providing the most thought provoking replies.

In hindsight, it would have been easier for everyone to follow had I provided more details - I was trying to keep it simple. I started with VA's 15 years ago and have 1035-ed a few times as well as having gone to cash with them in late 2007 (one VA transitioned to fixed via their market algorithm and I did the same with the other two). I fully understand and accept the rider fee drawbacks as a trade off for income for life. In 2009 I went back into one of them (market exposure) and I'm now drawing on the other two.

The one in question has a guaranteed 10% growth a year (simple) for 10 years on the deferred side with a guarantee of 5% a year withdrawal feature for life as well as 100% of the balance of PV after withdrawals if I die before 20 years. The sub account (portfolio side) has no indexing or guarantees. If the market is up, I'm up though I lag it due to the fees. Its value is almost a double now and is mine at any time, subject to taxation of gain. It has kept up with the deferred side and I'm in year nine. The 10 year deferred side has a year plus to run. Due to trading gains made in 2008-2009, my need for this particular income is no longer the issue so I'm more concerned with protecting current liquidation value, hence this hedging topic.

If I low/no cost hedge this with a 5% collar, it may allow me to avoid no more than a 5% loss (an approximate correlation assumption) and less if the puts aren't driven to parity after an ITM drop. If it challenges the upside, I can roll the collar up, locking in another 5% of gain while booking the loss on the ITM amount. If so inclined, I can liquidate a small portion of the VA to offset short call losses if they're significant.

Does this game plan make sense, give or take?

A collar is appropriate but you will lose money on the collar in a rally. So you have to be okay with funding those liquid losses while your illiquid annuity earns.

 

[spindr0]

Rolling a short call up when challenged generally did not work too well for me, costed too much. Even if I rolled up and out to buy time and collect theta, they generally did not work too well either.

I'm not a fan of rolling ITM covered calls up, booking a loss and carrying a paper gain. The market has a perverse way of making you pay for this. So the time to take action when defending is when the underlying approaches the short strike.

If you roll a call up, giving you further upside appreciation on the underlying, it will work out. Surely, not as well if you have not sold covered calls but it will make money because you get some add'l premium as well as well as add'l underlying gain.

This collar idea isn't exactly the same since there's no add'l premium received from rolling it up (there will be a debit) but the underlying appreciation will be there.

 

[spindr0]

A collar is appropriate but you will lose money on the collar in a rally. So you have to be okay with funding those liquid losses while your illiquid annuity earns.

That's true but I covered that scenario up above. If I sell a 20 delta call 5% OTM, I might lose approximately 30% of the gain if the rally occurs very soon. It could be more if vols expand but that's not likely to be much on a rally. Vols expanding would is more apt to occur in a correction and that helps the long put of the collar as long as it's not a crash, driving the put toward parity.

The funky part of this will be breaking the equity exposure out, determining the beta of that and basing the hedge on that. Or perhaps I KISS and just compare annual gain of each (entire annuity versus market) and let that be my beta - just thinking out loud...

 

[newwurldmn]

That's true but I covered that scenario up above. If I sell a 20 delta call 5% OTM, I might lose approximately 30% of the gain if the rally occurs very soon. It could be more if vols expand but that's not likely to be much on a rally. Vols expanding would is more apt to occur in a correction and that helps the long put of the collar as long as it's not a crash, driving the put toward parity.

The funky part of this will be breaking the equity exposure out, determining the beta of that and basing the hedge on that. Or perhaps I KISS and just compare annual gain of each (entire annuity versus market) and let that be my beta - just thinking out loud...

Don't worry about vols. You are short delta and will lose money proportionally when the market rallies. How you respond to that is a another decision you will have to make, but by then you will have lost money on the collar and made it on the annuity.

 

[spindr0]

Don't worry about vols. You are short delta and will lose money proportionally when the market rallies. How you respond to that is a another decision you will have to make, but by then you will have lost money on the collar and made it on the annuity.

I'm not worried about the vols at all. I doubt that it will affect me to the upside and it can only help on the downside since the long put is throwaway money funded by OPM.

I would have no problem with this collared VA rising 5% quickly and having to shell out 30% of the gain in return for buying back the short call, adding a new collar 5% higher and locking in 70% underlying appreciation. Not likely to happen much but I'd take it in a day, or preferably in two plus months with the pay off being 80-90%.

I'm not lost in pie in the sky numbers (gaining 5% per quarter). In late 2007 I set a mental stop around 10% and when it hit, I moved to cash. This time, a 5%/5% collar seems like a better approach.

Thinking this out a bit more, I need to drop 5 years or more of S&P data as well as the VA's value into a spreadsheet and see where the VA was every time there was a 5% S&P move in a quarter. If the numbers don't look great, I may have to shorten the duration of the collar, perhaps to two months. I can spitball option values quickly with my software. The end result won't be perfect but something in the ball park will suffice.

Thanks for your suggestions.

 

[newwurldmn]

I'm not worried about the vols at all. I doubt that it will affect me to the upside and it can only help on the downside since the long put is throwaway money funded by OPM.

I would have no problem with this collared VA rising 5% quickly and having to shell out 30% of the gain in return for buying back the short call, adding a new collar 5% higher and locking in 70% underlying appreciation. Not likely to happen much but I'd take it in a day, or preferably in two plus months with the pay off being 80-90%.

I'm not lost in pie in the sky numbers (gaining 5% per quarter). In late 2007 I set a mental stop around 10% and when it hit, I moved to cash. This time, a 5%/5% collar seems like a better approach.

Thinking this out a bit more, I need to drop 5 years or more of S&P data as well as the VA's value into a spreadsheet and see where the VA was every time there was a 5% S&P move in a quarter. If the numbers don't look great, I may have to shorten the duration of the collar, perhaps to two months. I can spitball option values quickly with my software. The end result won't be perfect but something in the ball park will suffice.

Thanks for your suggestions.

From what you have said throughout this thread, I get the sense that you want to protect the downside and are willing to sacrifice the upside. Then the collar is fine. It's a common structure for people to hedge illiquid positions (like Marc Cuban's famous Broadcast.com/Yahoo! hedge).