Hedging your portfolio against market down swings?

Discussion in 'Risk Management' started by pravinbs, Jul 28, 2022.

  1. pravinbs


    Retail investors lack the resources and avenues to build long/short dollar or delta neutral positions and more often long stocks and hope to build a diversified portfolio. While this insulates them from certain risks, our portfolios are still exposed to market shocks and down swings. There are several ways retailers can protect against such events:

    1. Using long PUT options on an index such as SPY.
    2. Using a short position on index futures.
    3. Using a long position on VIX futures.

    The challenge is to forecast when to hedge your portfolio and to this effect I have been reading various entropy based techniques that can predict contagion or spread of risk in financial markets. Of many such entropy based measures, I personally found Structural Entropy on financial correlation networks to be quite promising and you can find my attempts and experiment on hedging long portfolios with accompanied data and Python code here.

    I would be interested to know from other investors on their approaches to hedge their long only portfolios.
    Last edited: Jul 28, 2022
  2. MrMuppet


    all three are really bad hedges against market downturns

    1. Puts have a risk premium for correlation and gamma, so you'll overpay for them
    2. short position on index futures is not a hedge since it completely neutralizes your delta
    3. VIX futures have a gammut of secondary order risk

    The best hedge for retail is a tail hedge aka. sell the wings, buy the tail -> sell 25 delta puts to buy more 5 delta puts

    You'll most likely receive enugh $prem for the 25 delta to finance your crash protection or at least reduce the bleed to an acceptable amount. It is a gipsy hedge since it's only crash protection, but a put ratio is easy enough to manage for retail
    Last edited: Jul 28, 2022
    ET180, murray t turtle and cesfx like this.
  3. pravinbs


    Thanks. As I understand it is like a bear put spread only that short 25 delta puts need not be equal to long 5 delta puts. Does that mean if short 25 delta puts are ITM and long 5 delta puts are OTM we end up paying a cost for the hedge?
    earth_imperator likes this.
  4. @MrMuppet, not everybody, esp. not retail, understands the lingo used.

    Do you mean to open a ShortPut position with a strike that has a delta = -0.25 (-25%) and to open a LongPut with a strike that has a delta = -0.05 (-5%), both together forming a Put Spread?

    Can you give one or two practical examples? Or just a theoretical BSM dataset would be helpful too.

    Do you mean, for instance, such a BSM data set? :
    ShortPut: USpot=100 DTE=182.5 Strike=85 IV=45 --> Pr=5.67 delta=-25
    LongPut: USpot=100 DTE=182.5 Strike=40 IV=100 --> Pr=1.96 delta=-0.05

    Hmm. doesn't look good, IMO:
    Last edited: Jul 28, 2022
  5. fix: delta -25% and -5%, respectively
  6. cesfx


    It's a put ratio back spread Mr Muppet is talking about...

    Sell x1 put 25delta otm, buy (ratio) x2, or x3... of the 5delta put otm.
  7. IMO it's just wishful thinking, b/c I've already been there w/ my research: it's as follows:
    you short sell a high IV Put and buy a low IV Put (usually a lower strike) to form the spread.
    But, you have to wait till you can open the 2nd leg (LongPut) till its IV becomes low... :)
    Isn't it just this IMO self-deceiving case?
    Last edited: Jul 28, 2022
  8. cesfx


    You are talking about something else.

    Mr post was clear about the tail "crash" and the "ratio" parts.
    This ratio is 1:2, 1:3... Sell 1 : buy 2 or more.

    Not a 1:1 otm spread legged in on IV change, as for your research example.
  9. @cesfx et all: do you mean this? :
    Put Ratio Spread
    A put ratio spread is a multi-leg, neutral strategy with undefined risk and limited profit potential. The strategy looks to take advantage of a drop in volatility, time decay, and little or no movement from the underlying asset.
    But isn't that just a crappo for the trashcan? :D
    MKTrader likes this.
  10. cesfx


    Backspread.... inverse.


    #10     Jul 28, 2022