Ideas for a "conditional" hedge

Hi fellow traders,

I am trading a short term strategy in equities (holding time is a couple of days / less than a week), About 80% of the positions are long stocks and about 20% are short stocks.

Since I am mostly exposed long, I need some way to hedge the long positions because when the market falls, they loose more then the short position gain.

I can use a constant hedge - I calculate the beta of my long portfolio vs SPY,
lets say its size is $100,000, and its beta to SPY is 1.2, so I will short $120,000 SPY.

However, in the long run that hedge causes more losses and shrinks the profit from the long positions (usually when the market pulls up)

I am looking for a "conditional" hedge, meaning only have a hedge in certain situations when the market is more volatile and tends to go down more then up
(easy to say but hard to accomplish).

I would be very glad to hear any ideas / suggestions

BTW - I already thought about hedge when SPY < SMA(200) and do not hedge when SPY > MA(200), I like simple solution, but this doesn't work for me

Thank you,
Bob

 

Well, that's the nature of a short hedge - it will dilute profits from your long bias. There's no free lunch. However, it is possible that when fully hedged, you can take additional outperforming hedged long positions to offset this effect. The other alternative is to make the portfolio 50/50 with long/short stocks (assuming the additional shorts add alpha). A rather obvious suggestion, I know, but it's what I'd be striving for in your position.

I think you'll find this to be a fool's errand. The most disastrous sell off may come from a completely unexpected event. If your goal is to limit black swan type risk, then you could spend a portion of your pnl on penny puts in SPY, but if you're looking to smooth the pnl profile, a balanced portfolio is really your only option (in my opinion).

 

Hedging below 200 mov average is bad place to hedge because it is a strong reversal zone allot of the time so you hedge will immediately be a loss

 

Don't use to much of your account and just partially hedge the position

 

Sorry, you can disregard that. After rereading your post, I don't think it would make sense.

 

Sounds like your scared of the market by not just accepting market exposure, but you still want to be in the game. You have a long and a short and now you want a hedge. Is there money to be made in between? is the 80/20 strategy part of a proven mechanical trading strategy or an attempt at a semi-neutral market allocation?

Your conditional hedge is essentially market timing.....so now you want to time the market..... (insert market timing indicator here)

Maybe this can all be simplified by dialing down your equities allocation to tolerable levels.

 

I developed the strategy a long time ago and ran it live in the past 2 years with good results, however, 2013 was an "easy" year, I did not use the hedge much as it was a very bullish year, (if I would, it would halve the P&L), 2014 was a different story, used the hedge more, most of the time in a discretionary manner with the mechanical strategy.

The mechanical strategy gives good market exposure, but I would like it to be more balanced - meaning similar percentage of long and short positions, although I got good results when testing it and when running it live, I could not find a solution to "balance" the long / short exposure (for the short holding periods I use).

The description "time the market" is very correct, I think it is possible to do with various success. just using SMA200 can give decent results, but this is not what I need / want.

my wish is to find a method where I increase/decrease the hedge (like a dimmer switch) according to the market - when it is trending up, decrease the hedge (or not use it at all) and when the market is more volatile (like now) or when it is going down, increase the hedge.

I do not need a "perfect" solution (there is no such thing in trading), just something that would help to balance the long / short exposure.

Thanks,
Bob

 

You just answered your own question

 

Another way to view the problem. Rather than look at the hedges as a throttle for exposure. How about just buying insurance when it's cheap. It somewhat simplifies the problem and doesn't mess with the working strategy.

At the end of the day, you can measure the success of your hedging based on improved risk/return. With hedging/without hedging. Easy to backtest, too.

There are many ways to buy cheap volatility: based on absolute value of VIX, the skew and the term structure. In hindsight, buying on the absolute value of VIX seems most simple and effective. Pick a number and backtest. But of course, markets change.........