Best of the Week
Most Popular
1.US Paving the Way for Massive First Strike on North Korea Nuclear and Missile Infrastructure - Nadeem_Walayat
2.Trump Reset: US War With China, North Korea Nuclear Flashpoint - Video - Nadeem_Walayat
3.Silver Junior Mining Stocks 2017 Q2 Fundamentals - Zeal_LLC
4.Soaring Inflation Plunges UK Economy Into Stagflation, Triggers Government Pay Cap Panic! - Nadeem_Walayat
5.The Bitcoin Blueprint To Your Financial Freedom - Sean Keyes
6.North Korea 'Begging for War', 'Enough is Enough', is a US Nuclear Strike Imminent? - Nadeem_Walayat
7.Bitcoin Hits All-Time High and Smashes Through $5,000 As Gold Shows Continued Strength - Jeff_Berwick
8.2017 is NOT "Just Another Year" for the Stock Market: Here's Why - EWI
9.Gold : The Anatomy of the Bottoming Process - Rambus_Chartology
10.Bitcoin Falls 20% as Mobius and Chinese Regulators Warn - GoldCore
Last 7 days
1987 Stock Market Crash 30th Anniversary Greatest Investing Lesson Learned - 19th Oct 17
Virgin Media Broadband Down, Catastrophic UK Wide Failure! - 19th Oct 17
The Passive Investing Bubble May Trigger A Massive Exodus from Stocks - 18th Oct 17
Gold Is In A Dangerous Spot - 18th Oct 17
History Says Global Debt Levels Will Lead to Another Crisis - 18th Oct 17
Deflation Basics Series: The Quantity Theory of Money - 18th Oct 17
Attractive European Countries for Foreign Investors - 18th Oct 17
Financial Transcription Services – What investors should know about them - 18th Oct 17
Brexit UK Vulnerable As Gold Bar Exports Distort UK Trade Figures - 18th Oct 17
Surge in UK Race Hate Crimes, Micro-Racism, Sheffield, Millhouses Park, Black on Asian - 18th Oct 17
Comfortably Numb: Surviving the Assault on Silver - 17th Oct 17
Are Amey Street Tree Felling's Devaluing Sheffield House Prices? - 17th Oct 17
12 Real-Life Techniques That Will Make You a Better Trader Now - 17th Oct 17
Warren Buffett Predicting Dow One Million - Being Bold Or Overly Cautious? - 17th Oct 17
Globalization is Poverty - 17th Oct 17
Boomers Are Not Saving Enough for Retirement, Neither Is the Government - 16th Oct 17
Stock Market Trading Dow Theory - 16th Oct 17
Stocks Slightly Higher as They Set New Record Highs - 16th Oct 17
Why is Big Data is so Important for Casino Player Acquisition and Retention - 16th Oct 17
How Investors Can Play The Bitcoin Boom - 16th Oct 17
Who Will Be the Next Fed Chief - And Why It Matters  - 16th Oct 17
Stock Market Only Minor Top Ahead - 16th Oct 17
Precious Metals Sector is on Major Buy Signal - 16th Oct 17
Really Bad Ideas - The Fed Should Have And Defend An Inflation Target - 16th Oct 17
The Bullish Chartology for Gold - 15th Oct 17
Wikileaks Mocking US Government Over Bitcoin Shows Why There Is No Stopping Bitcoin - 15th Oct 17
How to Wipe Out Puerto Rico's Debt Without Hurting Bondholders - 15th Oct 17
Gold And Silver – Think Prices Are Manipulated? Look In The Mirror! - 15th Oct 17
Q4 Pivot View for Stocks and Gold - 14th Oct 17
Gold Mining Stocks Q3’17 Preview - 14th Oct 17
U.S. Mint Gold Coin Sales and VIX Point To Increased Market Volatility and Higher Gold - 14th Oct 17
Yuan and Gold - 14th Oct 17
Tips for Avoiding a Debt Meltdown - 14th Oct 17
Bitcoin Hits New All-Time High Above $5,000 As Lagarde Concedes Defeat and Jamie Demon Shuts Up - 13th Oct 17
Golden Age for GOLD, Dark Age for the Stock Market - 13th Oct 17
The Struggle for Bolivia Is About to Begin - 13th Oct 17
3 Reasons to Take Your Invoicing Process Mobile - 13th Oct 17
What Happens When Amey Fells All of a Streets Trees (Sheffield Tree Fellings) - Video - 13th Oct 17
Stock Market Charts Show Smart Money And Dumb Money Are Moving In Opposite Directions—Here’s Why - 12th Oct 17
Your Pension Is a Lie: There’s $210 Trillion of Liabilities Our Government Can’t Fulfill - 12th Oct 17
Two Highly Recommended Books from Bob Prechter - 12th Oct 17

Market Oracle FREE Newsletter

3 Videos + 8 Charts = Opportunities You Need to See - Free

How to Safely Hedge Your Stocks Portfolio in Uncertain Times

Portfolio / Learning to Invest Mar 08, 2013 - 03:08 PM GMT

By: Investment_U

Portfolio

David Eller writes: What a year 2013 has been. The S&P is up 6% and we’re 3% away from all-time highs. The Dow Jones broke through 14,000…

Can things get better from here? Can they even stay this good? Nobody knows where the markets will go, but there are ways to protect yourself and sleep easy at night.


Personally, I’m not a believer in short selling individual stocks. The deck is stacked against you. The Fed wants asset prices to increase, company management teams want stock prices to rise and sell-side investment analysts constantly prop up share prices of weak corporations. This is just too much to compete with when there is easier money to be made buying stock of good companies.

However, if you are concerned about protecting gains, short selling an index can be an effective way to lock in profits, without liquidating your portfolio. Why go to the trouble?

Let’s say you’re fully invested in The Oxford Club’s Oxford Trading Portfolio. This consists of 25 stocks in diverse industries. It could make sense to keep your positions on for tax purposes, to capture the dividends, or just because you think these stocks will outperform if the market sells off. How can you protect yourself?

Some methods are better than others, so we analyzed the five major pullbacks over the last three years to find the best ways to hedge. We also uncovered some useful takeaways that can help you protect your hard-won gains.

Shorting SPY isn’t an efficient hedge.

The first option that comes to mind is shorting the S&P 500 tracking stock, the SPY. It makes sense this would protect your downside on a one-for-one retreat in the S&P 500. But unfortunately, empirical evidence shows this isn’t the case.

According to the second table, the SPY only pulled back 88% of the decline. And in Table 1, it retraced a smaller percentage than the S&P in each of the five pullbacks. While it is possible to short the SPY to protect gains, it clearly isn’t efficient.

Buying VXX is like juggling chainsaws.

The most dangerous method may also be the most talked about. The financial press loves to discuss a fear gauge known as the VIX. If you time an investment in this security perfectly, you can see dramatic returns. During the market sell-off between April 2 and June 4 of 2012, the VXX returned 29% compared with a 9.6% drop in the S&P. It also increased by 3.8 times the pullback of the S&P 500 on average over the last five meaningful declines.

The returns are great… But in my opinion, investing in this security could be compared with juggling chainsaws. Your timing has to be perfect. If you had left the position on until June 20, the return would have dwindled to -5%, even though the S&P was still down -6%.

The VXX loses money every day in a normal market because of the way it rebalances. Each day, the VXX has to buy a certain percentage of VIX contracts, two months out, while selling that same percentage of contracts one month out. Because time is a component of option value, the longer-dated options usually cost more. This drives down the value of the fund as cheaper contracts are replaced with more expensive ones.

Buying SDS is expensive, but doesn’t require a margin account.

Inverse index ETFs such as SDS are another option – and you don’t need a margin account for this strategy. The SDS tries to mimic performance that is twice the inverse of the daily return of the S&P 500. If the S&P falls 2%, the SDS should rise 4%. We back-tested this security against the SPY and found it tracks the index closely.

The SDS is volatile, but it does what it claims to do. However, it can eat up a lot of your buying power. When you sell a stock short, you borrow the security from your broker and sell it to somebody else. Margin interest is not paid on the total value of the security. It is only paid on the dollar value the position moves against you. Imagine you sold short 100 SPY at a price of $150. If the position moves against you to $151, you would be paying margin interest on $100 instead of $15,100.

Shorting SSO provides both leverage and correlation with the S&P 500.

The SSO is the reverse of the SDS. It is a levered, long ETF that tracks the S&P 500 closely. On average, it fell 1.72 times the range of the S&P 500. If a person wanted to fully hedge a $100,000 portfolio, it could be done with $58,000 ($100,000 / 1.72 = $58,140). The investor would also only need to pay interest on the loss of the hedge, rather than the full amount.

If you have a diversified portfolio, you are naturally hedged against an upward drift in the market; shorting an index or buying an inverse ETF are ways to accomplish this goal. But remember, some methods are more volatile and require a margin account, so be sure to consider your personal situation and tolerance for risk when selecting a strategy.

Good Investing,

by David Eller,

Source: http://www.investmentu.com/2013/March/how-to-safely-hedge-your-portfolio-in-uncertain-times.html

http://www.investmentu.com

Copyright © 1999 - 2012 by The Oxford Club, L.L.C All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Investment U, Attn: Member Services , 105 West Monument Street, Baltimore, MD 21201 Email: CustomerService@InvestmentU.com

Disclaimer: Investment U Disclaimer: Nothing published by Investment U should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Investment U should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Investment U Archive

© 2005-2017 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife