Does Anyone Use Options to Hedge their Stock Portfolio?

Discussion in 'Options' started by tvgram, Sep 14, 2007.

  1. tvgram

    tvgram

    I know that OptionVue 5 (which I use) has a tool called HedgeFinder that lets you graph a portfolio of stocks and options against an index (say the S&P 500) that tell you how much you are likely to gain/lose based on movements of the SPX.

    It also has a tool that will automatically recommend the best hedge based on parameters you input (how long you want to hedge for, what % drop in value are you willing to tolerate). I was even looking at an article on their educational site that talks about using options to insure a Portfolio:

    www.discoveroptions.com/public/cont...options/strategiesandtheuseofoptions.html#top

    But I notice if I run it that it seems like it is very expensive to hedge against, say, a 5% decline all the time. Other articles I have seen say the rule of thumb is that it costs 3% of a Portfolio's value to insure it.

    My question is if there is anyone that has ever actually tried this over the long term? If so, did you find that the cost (lower return) each year you had to accept each year the market was up was eventually made up (and hopefully more) in down years?

    Or are you perhaps better off trying to minimize the costs by only hedging when you feel there is a good chance the market will decline? (at the risk of not guessing correctly and having a market correction when you are not hedged).

    Any thoughts or experience anyone has on this would be very interesting to me.
     
  2. If by "hedging" you mean buying puts corresponding to the stocks you own, I agree it's expensive and not worth it.

    If you own shares and puts on the same underlying, that's equivalent to owning the call with the same strike and expiry. If you think of it that way, it's a portfolio you would probably never own. Imagine having an account full of cash, and buying ITM/DITM calls every month or two. If that's not your idea of a good time, don't own shares and buy OTM puts every month or two.

    There are other ways to hedge a portfolio of shares. Basically, anything that makes money when your stock doesn't go up is a valid hedge. Consider vertical spreads (much cheaper than buying puts), collars (collar plus shares is equivalent to a vertical spread) and even covered calls.

    There is no free insurance in the market. You can't hedge without paying something. If you buy options, you pay cash for the time premium. If you write options, you give up profits in a certain price range. The beauty of options is that you get to decide how you want to pay, and what risk you want to hedge. Tailor your hedge to your outlook for the stock, and you'll sleep well at night.
     
  3. tvgram,

    Since I don't want it to go to his head, let's just say that someone who replied to you gave you some pretty good info (g)

    >> There are other ways to hedge a portfolio of shares. Basically, anything that makes money when your stock doesn't go up is a valid hedge. Consider vertical spreads (much cheaper than buying puts), collars (collar plus shares is equivalent to a vertical spread) and even covered calls.

    There is no free insurance in the market. You can't hedge without paying something. If you buy options, you pay cash for the time premium. If you write options, you give up profits in a certain price range. The beauty of options is that you get to decide how you want to pay, and what risk you want to hedge. Tailor your hedge to your outlook for the stock, and you'll sleep well at night. >>


    If you want some protection for your portfolio AND you don't want to pay much for it AND you are willing to give up some of the potential upside gain if exercised AND you are willing to give up your stock at a higher price if exercised then consider collars where you sell an OTM call and use the proceeds to buy an OTM put.

    If not, then just start another thread here :)
     
  4. tvgram

    tvgram

    For selling OTM calls, were you talking about doing that on each stock individually (if they have options trading)?

    Because I did notice that there is the ability to not only get the recommended number of puts to purchase in chosen index (say the SPX), but then you also have the further choice to look for call credit spreads to sell to help pay for the puts (and basically create a collar on your entire portfolio).

    The idea is supposed to be that, since you do not actually have a position in the SPX, you do not want to sell naked calls, so you sell call credit spreads to minimize risk and margin required.

    I do try to keep some ETF holdings that are usually uncorrelated with the market, both to try and guess what sectors might outperform in the next year or so as well as to diversify.

    So I am really talking about hedging the risk left after you diversify, or basically using the Beta of each holding relative to the index to come up with should be the equivalent number of shares in the index, and using that number to decide how many puts to buy (although you can of course only partially hedge).

    I suppose you could also convert it to something like equivalent shares in the SPY, and then simply short that many SPY shares to make it close to perfectly flat, if you were that worried the market might crash. But in that case it would seem to be easier to just liquidate everything and buy Tbonds.