Hedging

[stockoptionstrader]

Hi all,

Would this kind of method work?:

Portfolio with

100 000 $ long in stocks

100 000 $ short in options (equivalent of 100 000$) if the market crashes (as an insurance)

Will this work or is it not worth the effort because of the large cost of insurance you pay in case something bad happens?

Are there less costly ways to hedge your portfolio?

TIA

 

[haroldg]

I think you meant to write 'long in [put] options,' in which case the answer is yes.

 

[lindq]

Are there less costly ways to hedge your portfolio?

TIA

And when your 100K in stocks rallies 10%, are you going to be happy about the cost you paid for insurance?

Not likely.

 

[BigTommy]

It can work, but that insurance can be really expensive. Usually, you would go long put options well under the money, that way you'll actually lose some fixed amount before your options kick in and start limiting your losses.

For example, if you long stock is at $100, you could buy puts at $75 and you won't lose more than 25%. If you instead bought the puts at $100, you'd never make any money because they cost too much.

Alternatively, you could just forget buying the stock and instead buy in-the-money call options, which do essentially the same thing as long stock + long put option. You just have to run the numbers and see what works for you.

 

[Tim Smith]

Are there less costly ways to hedge your portfolio?

Yes.... don't hedge.

Hedging is not a pancea, its not a guarantee, and its not as easy to get right as the textbooks like to make out.

As @lindq says, you'll pay for the "insurance", and on top of that, you'll probably "pay" by getting your hedging wrong and end up in a zero-sum game.

I know people running multi-million portfolios. They hedge neither assets or currencies, never have, never will. Said portfolios are old enough to have lived through 2008 etc. and are none the worse for it.

Focus on solid portfolio construction first. Nothing wrong being 100% long.

 

[BigTommy]

By the way, you might want to take a look at the book "Buy and Hedge," which deals with this concept in length.

http://www.amazon.com/exec/obidos/ASIN/0132825244/tulind-20

 

[haroldg]

And when your 100K in stocks rallies 10%, are you going to be happy about the cost you paid for insurance? Not likely.

That's silly -- it's like saying "When your house doesn't burn down, are you going to be happy about the cost you paid for insurance?"

 

[Sweet Bobby]

I always maintain negative deltas in my portfolio. I also don't use more than 34% of my buying power in the portfolio. I believe the key is not to be too big.

 

[Jones75]

Hi all,

Would this kind of method work?:

Portfolio with

100 000 $ long in stocks

100 000 $ short in options (equivalent of 100 000$) if the market crashes (as an insurance)

Will this work or is it not worth the effort because of the large cost of insurance you pay in case something bad happens?

Are there less costly ways to hedge your portfolio?

TIA

I'm a big fan of the "delta neutral put" for locking in profits against stock, and major ER gyrations. If you go to far out (date), the bid/ask spread ruins the whole trade, so serious liquidity to keep it tight, is paramount.
If you're a long term investor, married puts could end up being too costly. IMO, better off using stop losses, which I'm not a proponent of…but good luck…

 

[lindq]

That's silly -- it's like saying "When your house doesn't burn down, are you going to be happy about the cost you paid for insurance?"

I don't expect my house to burn down often, so it is worth the small cost of insurance. But trying to protect a stock portfolio with puts requires spending serious money on a regular basis, and betting that X will happen during Y period of time.

No thanks. Been there and done that.