Hedging An Appreciated Portfolio

Discussion in 'Options' started by spindr0, Dec 11, 2017.

  1. spindr0


    Yep, you got it. I want to put a floor under the gains (nearly a double at this point) but have the opportunity to participate to the upside, even if it's not at 100% (possible collar loss). With a little luck, the upside participation will continue since I doubt that we'll have many years of 20% gain like this one (a guess, not a prediction).
    #31     Dec 15, 2017
  2. newwurldmn


    From the way collars price you will give up more upside gains than you will get in downside protection.
    #32     Dec 15, 2017
  3. spindr0


    Yes, that is a problem since a no cost collar might have to be -9% / +5% or if balanced (-5% / +5%), for a decent debit cost.

    I would assume that all broad based ETFs follow this pattern. Yes?
    No free lunches anywhere? :rolleyes:
    #33     Dec 15, 2017
  4. newwurldmn


    maybe the kospi or Nikkei... but that will create all sorts of basis risk for you.
    #34     Dec 15, 2017
  5. spindr0


    Nah, that's too sophisticated for me.
    I prefer blunt force trauma.
    #35     Dec 15, 2017
  6. newwurldmn


    I wouldn't do that either. I would do the collar if you can support the liquidity mismatch or I would just liquidate the annuities if the fees and tax implications aren't too bad.
    #36     Dec 15, 2017
  7. spindr0


    The tax implications are problematic since it's 6 figures of gain and any withdrawals are LIFO.

    Probably TMI but there are many 1035 swap choices out there. So far, I've found:

    A 5 year fixed pays 2.65%.

    A 10% "buffered" variable provides a annual 10% cap on market profits with 10% no risk below but you bear all the risk after a 10% loss.

    A 7 year indexed annuity provides up to 5.5% per year with 100% protection of principal.

    AFAIC, these all suck.

    At this point, supporting the mismatch makes the most sense. But I'm still looking for something or someone clever. That someone would have to be someone out there who understands both options and annuities and it's hard enough finding someone who really gets one.

    Thanks for your ongoing suggestions.
    #37     Dec 15, 2017
  8. spindr0


    I have some more questions for roughing out what I'm considering.

    With the SPY at $266.50, a 3 month no cost collar would be a Mar 2018 245p/280c.. That represents an 8% max loss and 5% upside potential.

    An equidistant 253p/280c collar would cost about $1.40 out of pocket which is 28% of maximum of the SPY's upside gain.

    Assuming direct correlation, to hedge each $100,000 of the managed money, would the number of collars needed be $100,000 / $26,650 ?

    Suppose the portfolio is 75% equity and 25%. That means that I need 3/4 the number of collars of the above calculation. And again, assuming direct correlation, to the upside the portfolio will earn 3.75% when the SPY rises 5% so perhaps I need a different collar width. And to complicate things, if I'm doing an equidistant collar (5%) that costs $1.40 out of pocket and I'm only netting 75% of the SPY's gain, not looking so good at this point.

    I'm just thinking out loud and would appreciate any additional feedback and suggestions.
    #38     Dec 17, 2017
  9. spindr0


    OK, the ongoing saga of hedging non correlated assets. I apologize for the length but I'm looking for HELPPPP !!! :->)

    In 2009, I took some of my trading profits and bought a variable annuity for the purpose of guaranteed income for life once I reached 65. It has nearly doubled in value in 9 years. I have two others VAs which I am drawing income from and I have decided that I do not need this 3rd VA for that purpose. My objective going forward is to keep some upside exposure to the market but incorporate some sort of floor of protection on the appreciation.

    Earlier in this chain I toyed with the idea of collaring this VA with SPY options in my IB account. ATM long puts are too much of a drag on performance. Nix that. I mentioned a -5% / +5% collar but that would be modestly out of pocket since puts cost more than calls - not a big problem. A -8% / +5% could be done for no cost. The correlation is problematic because the VA is a 90/10 equity/fixed. It's doable but there might be a bit of variance and how much that is, is unknown. So I'm exploring other possibilities and writing this out for two reasons. One, it focuses me and helps me to flesh out some pitfalls and second, hopefully some feedback can keep me moving forward.

    The are some 'buffered' annuities (SIO-s). If I accept a 10% annual cap on profit (several indexes can be used), I can be protected from the first 10% of drop. I initially dismissed this idea because I would bear all of the risk after a 10% drop. But after further thought, I realized that put protection 10% OTM is fairly cheap. Currently, the annualized SPY cost for nearer months (Feb, Mar) is about 1.35% and going out 1 full year would be about 2.5%. So while I bear all of the risk in the current VA, shifting to this SIO would provide a 6:1 to a 3:1 R/R, depending on the month utilized.

    For example, if I put 100k in, the intial buffer would be 90k/110k. At the end of one year:

    - if over 110k, I'm worth 110k and my second year buffer steps up to 99k/121k.

    - if b/t 100k and 110k, I'm worth whatever that value is.

    - if b/t 90k and 100k, I'm worth 100k.

    - if less than 90k, I'm worth 100k minus anything below 90k (if value dropped to 82k, the first 10k of loss is protected and SIO is worth 92k)

    I don't know where adviser fees fit in. If they come out of the 10%, it's a problem. If it's 10% after fees, not a problem.

    Hedging: If I buy 10% OTM SPY puts, I'm fully protected, less the put cost. With the SPY at 270, four Mar $243 puts would hedge 108k. At a cost of 70 cts per put, that's about 1.35% a year. So best case scenario, I make 8.65% a year and worst case is -1.35% per year.

    If the SPY rose, my 10% OTM strike would rise at the end of each quarter. For example, with a 5k SIO gain by Mar expiry, my June 10% OTM puts would be at the 95k level. If the SPY crashed, I'd make up to 5k more on those puts (105k drops to 90k, my puts make 5k and I get 10k from the SIO so I'm whole).

    Sounds too good to be true and in writing this, I realize that it is. If the market drops by March, re-upping the hedge at the 90k level is going to cost me more premium than the first hedge since the puts will be less OTM. If instead, I hedge 10% away from the SPY (say at 85k with market value at 95k), I now have another 5k of loss potential on top of the put cost.

    Given that, it means that I have to spring for a 1 year put LEAP at the outset so that my protection is locked in at 90k until the buffer resets at the one year and then buy another 1 year put based on 10% below the 1 year SIO value. This currently costs 2.5% and drops the R/R to 3:1.

    Another possible speed bump is that a bump up in implied volatility will increase the hedging cost and drop the R/R ratio. I should also consider a lower strike, trading hedge cost for less risk protection (say at the 85k level).

    Bear in mind that this idea is geared toward converting 100% market at risk money into something safer but potentially better than a MM or CD return. If the sh*t hits the fan again, as it did in 2008, I'll go back into the volatility trenches and trade merrily. That's a different game. This money is safe money.

    So, does anyone have any suggestions as to possible pitfalls or other kinks I'm not seeing with the hedging aspect? TIA
    #39     Jan 3, 2018
  10. spindr0


    I'd like to thank those who contributed constructive replies to this chain. I'm a happy clam right now because two weeks ago I cashed out of the aforementioned variable annuity which nearly doubled in the past 9 years. I got the top.

    I took 1/2 the proceeds and put it into a 10% "buffered" variable annuity which provides a 10% annual cap on profit with protection against the first 10% of loss. I also bought some puts 10% OTM to extend the downside protection. The gains went into the sheltered MM.

    As the volatility levels off and the B/A of the options narrows back to a sane width, I'm going to roll the long OTM puts down (they're not that far from being ATM), pulling out gains and lowering my cost basis. If necessary, I'll take the haircut but I'm going to try to avoid it. It's not a winning strategy if the market continues to collapse (net delta is against me) but it will soften the blow and I'm betting that I can book a chunk before my 10% buffer is exhausted. And if there's ever a rebound, I'm ahead sooner. So again, thanks.
    #40     Feb 5, 2018
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