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# Formula For Volatility Adjusted SPY Hedge

Discussion in 'Risk Management' started by jayjay121, Mar 22, 2012.

1. ### jayjay121

hi, can anyone help me?

Ill explain what Im trying to achieve.

Say Im mostly long or short a basket of 20 stocks. To protect myself how would i set up a SPY hedge?, what is the formula if any?........ideally something i can set up in Excel would be good.

When trading most days i have equal shorts and longs so pretty market neutrel, but on some days i get i can get lopsided and be mainly directional with my stocks. So on these days how can i reduce my risk with a SPY hedge?, but also how do i know how many SPY shares to buy/sell against what stocks i already have in the basket?, to make the basket as market neutrel as possible. Please help as im struggling to get my head round the formula needed to start a spreadsheet. Its the knowing the correct postion size at the time of the hedge that is getting me.

I suppose Im looking for a formula that will put me pretty dollar neutrel so the SPY hedge matches with the rest of the basket.

kind regards,

I would look at cash neutral. If your basket of stocks is long \$250K, hedge it with SPY or SPY options based on that value.

EG. long portfolio value / current SPY value = hedge ratio

\$250,000/139 (SPY price)=1798

So either sell 1798 shares of SPY to hedge out market risk, or 1798 deltas in SPY. There are different ways to beta adjust etc, but this is a quick and dirty way to back test your hedge. With this, your goal would be to hedge out beta risk and have alpha risk left.

Bob

3. ### jayjay121

hi, thanks for the reply, this simple formula looks just what ive been missing. I knew it would be something simple.

kind regards

For your information im not pair trading, just sometimes i get lopsided but dont want market direct to be part of the strategy, will your formula still be valid?

4. ### Rationalize

It depends entirely on what you own vs the SPY basket.

If you owned the whole basket in the right weights, you'd be pretty neutral on most fronts.

Start by netting the components, to see what you have not flattened.

No, not volatility adjusted. I don't recommend over hedging. In my opinion, simple is better.

6. ### Rationalize

Need to net the deltas as step 1.

7. ### newwurldmn

get beta flat. not notional flat.

8. ### Rationalize

Isn't that making a pretty big correlation assumption?

9. ### newwurldmn

Yeah it is. It's also making a volatility assumption. But if you are net long 100k of bac clearly 100k of spy won't be a sufficient hedge. And of you are short 100k of NLy the. 100k of spy would be an over hedge.

Whatever ratio you use will be more art and science, but you need to account for the correlation an the vol somehow and beta does that kind of.