How big should a hedge be?

[Handle123]

Hi All,

I am trying to figure out how big my hedge positions should be. I'm assuming that it should be a proportion of the primary position but I am having difficulty finding the right balance.

any comment would be appreciated.

Thanks,

Ricky

I believe most on the forum have no idea of how to hedge as they don't do it and give generalizations of what they think it entails. I have been on knowledge hunt past seven years on hedging and risk management. Most have thought you put on options and walk away, and that is not the best activity to do. You need to have better idea of when you need to put on the hedge whether it is shorting the ES or bigger SP futures contracts, or individual stocks or SPY or buying put options. Cause the best time to put them on is just before you need the insurance. Since options don't go one for one till much closer to expiration, you have to decide if you want to do 2 to 1 ratio as an extreme to equal out the underlying losses. I usually do 1.5/.75 to 1.

You might want to consider doing a percentage loss like a trailing stop, but instead of being stopped out you put on your hedge, this saves you from ongoing option losses if markets continue to rise.

 

[ironchef]

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,

I would reword your comments to include what Pekelo said: Hedging will cost you profits. For example, he can do a no cost collar to protect his current position on PayPal for down side risks at no cost but he would be giving up some future upside profits.

 

[ironchef]

Since options don't go one for one till much closer to expiration, you have to decide if you want to do 2 to 1 ratio as an extreme to equal out the underlying losses. I usually do 1.5/.75 to 1.

You might want to consider doing a percentage loss like a trailing stop, but instead of being stopped out you put on your hedge, this saves you from ongoing option losses if markets continue to rise.

Very interesting comments. I got to think about this really hard. May I ask you a couple of questions:

1. What type of ratio are you refer to? e.g., buying ratio put instead of full 1:1?

2. Are you saying instead of a trailing stop, do a dynamic hedge? For us small retail traders, that can be expensive?

Thank you for sharing.

 

[Handle123]

Very interesting comments. I got to think about this really hard. May I ask you a couple of questions:

1. What type of ratio are you refer to? e.g., buying ratio put instead of full 1:1?

2. Are you saying instead of a trailing stop, do a dynamic hedge? For us small retail traders, that can be expensive?

Thank you for sharing.

1. Two Puts to 100 shares of stocks, you can recoup your losses on shares at faster pace and actually make profit as the Premium will get larger if prices go down. If you just have 100 shares, I rather have too many Puts than too few unless you doing expiration that is far closer than say six month duration Puts.

2. In my case and I am sure others, bought "core" stocks in 2009 and all dividend paying, so if presently paying 3%, which is very huge compared to price paid in 2009, I won't sell stocks on a 5% decline, so if longer term investor can take a lose of 5%, they can at minus 5% then buy ATM Puts to hedge their position. This saves funds of buying Puts too soon, this all is a guessing game, but it is better it one has patterns of longer term reversal patterns based on weekly and or dailies. This is not to say every reversal will show up on charts, but often times do give hints market tiring out.

Ends of Bull market, the signs generally come early defined by "breadth" indicators, New Highs/New Lows start declining, Transportation declining, Cardboard companies declining, Long Haul trucking companies declining/LTL staying neutral(means companies have switched to JIT loads-small number of pallets), and other stats, we all have different favorites. Masses are generally wrong.