1 / 15

Hedging

Hedging. 1. Objectives. a. What is a hedge? b. When to use a hedge c. Instruments and strategies d. Examples. 2. Definition.

kerri
Download Presentation

Hedging

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Hedging

  2. 1. Objectives • a. What is a hedge? • b. When to use a hedge • c. Instruments and strategies • d. Examples

  3. 2. Definition • A hedge is an investment position intended to offset potential losses/gains that may be incurred by a companion investment. In simple language, a hedge is used to reduce any substantial losses/gains suffered by an individual or an organization. • Protection against losses, lock in profits , Price risk transfer , Lower portfolio volatility

  4. A Hedge is an Insurance Policy • Like all insurance there are costs. A more effective hedge is often more expensive. Finding your ”sweet spot” between cost and protection

  5. 3. Must determine what you’re hedging against • a. General market decline • b. Market sector decline • c. Company specific (earnings, overvaluation etc..) • d. Static Market

  6. 4. Instruments • a. Best Hedge is Cash. Not always practical • b. Options • c. Inverse ETF • d. Futures

  7. 5. Option Strategies for General market decline • a. Index or Sector Puts • b. Index or Sector Bear Put Spread (Warning – increasing IV of short put can limit gains) • c. Puts or bear put spreads on Individual Stocks in Portfolio • d. Collar • e. Option Replacement • f. Bear Call Credit Spreads • g. VIX calls. • h. SPY/VIX paired trade • i. Binary Strategies: OOM VIX calls, ‘Fly, OOM Bear put spread

  8. 6. Inverse ETF strategies for General Market Decline • a. Major Index : ex SDS • 1. buy-stop • 2. Beware effects of negative compounding • b Weak on underperforming sector : ex SRS • 1. buy-stop • 2. Beware effects of negative compounding • c. Volatility ETF: ex VXX • 1. Beware the effects of VIX futures contango. This will limit your effectiveness. More effective when Futures term structure is flat or backwardation

  9. 7. Option Strategies for hedging individual stocks • a. Put Purchase • b. Put spread--- straight, ratio • c. Collar/Conversion

  10. 8. Strategies for hedging a Static market • a. Covered call writing • b. Credit spreads • c. Covered Strangle or Straddle

  11. 9. Example of a collar • Bought 100 shares LMT march 2009 at $60/ share or $6000 • Now LMT is $126 share value of $12600( 110% gain) and investor wants to protect his gains till Jan 2014 • Buy Jan115s put @ 2.55 for debt of $255 • Write Jan 130s call @ 2.75 for credit of $275 • Net credit $20 • So if LMT is less than $115/share on 1/1/14 investor can sell put • or exercise put. If investor exercises put his position will never be worth less than $115.20/share or a 92% gain. If LMT closes over $130/share investor’s stock will be called away for a credit of $130.20 or a 117% gain.

  12. 10a. Example of using index options to hedge a hypothetical portfolio. ( Beta hedge : Beta , Delta hedge) • Assume a 3 stock portfolio, $10,000 or each purchased Oct 2011. ( note PL , ASPS have illiquid options) • Stock Purchase Price Oct 2011 Price Aug 2013 % gain • WLP 62 86 39% • PL 15 43 186% • ASPS 35 127 262% • Shares Value Aug 2013 Beta • WLP 161 $13,850 .86 • PL 666 $28,640 3.02 • ASPS 285 $36,200 .55 • Portfolio beta = 1.5 $78,690

  13. 10b. Example of using index options to hedge a hypothetical portfolio. ( Beta hedge : Beta , Delta hedge) • So to hedge with SPY options need to adjust number of contracts for the portfolio beta • (78,690)(1.5) = $118,035 • If SPY is 166.62 then need 118,035/166.62 contracts or about 7 contracts • However your put option has a delta less than one so need to “delta hedge “as well • Sept SPY 166s put. 2.35. Delta .44 • So to establish a delta neutral position where you have locked in the value of the portfolio • Buy 7/.44 or 16 SPY 166s put contracts • ( 16)( $235) = $3790 or 4.8% of value of portfolio • Beta hedge only • (7)($235) = $1645 or 2.1% of value of portfolio

  14. Follow up on delta neutral hedge • SPY drops 2 points to 164.62. The puts should trade at 3.30 with a delta of .57 • (7) / (.57) = 12.3. • Only 12 puts are required for delta neutral hedge so…. Sell 4 contracts @ 3.30 and remove $1336 from position.

More Related