How big should a hedge be?
- Thread starter Rickylee
- Start date
This is true for everybody but handle.
Hedging is basically a fancy term for insurance.
The more insurance you want to be covered for...the more your premiums will be.
It's as simple as that.
it's your call...where you want to fall on that spectrum. No one else can answer that question, but you,
Your hedge should be of appropriate size to give the desired recovery should the event it's hedging against occur. Hedging against a 20% market wide downturn looks very different from a sector hedge against 5% moves.
It looks vaguely like you're asking this from an investor's point of view. You'll figure out quickly applying the metric above will come at a cost likely higher than you wish to pay, if that's in fact the case.
It looks vaguely like you're asking this from an investor's point of view. You'll figure out quickly applying the metric above will come at a cost likely higher than you wish to pay, if that's in fact the case.
Chuck Norris doesn't hedge! But if he did, he would hedge his long SPY with Short ES and make money on both sides! Joking aside, are you looking to protect against overnight event risk or obtain reduced margin requirements? How much percent single stock and or portfolio drawdown is acceptable to you? Depending on equity investment type, overnight risk could range from 5 to 40 percent.
For example, say your overnight risk tolerance is 5% and your perceived overnight risk is 20%. Divide your risk tolerance by your perceived risk for your acceptable exposure. Hedge the remainder.
So 5% / 20% = 25%. Hedge 75% of your investment. Proof: 25% exposure X 20% overnight risk = 5% acceptable risk. Intraday risk tolerances are typically much less than this number.
Note, with multiple investments, you would want to use a spreadsheet and would want to take into account of the effect or benefit of multiple investments on risk.