Hedging

[the blades]

As I’m here, I’ll continue…

Why I think Blades, you may be into a diminishing returns for effort and energy situation (I think you’ve already recognised that a day or so back and why you indicated you’ll carry on as you have been) is that it’s going to be a little difficult for you to assess your portfolio on a dynamic basis to the degree necessary to determine precisely the corresponding options play to counterbalance your investment and protection aims at every point in time during the life of your trade.

Your basket will unlikely directly correspond in the constituents or constituent weightings to the index, and that’s even if you only chose stocks which are constituents of the index. If you select an improper subset (some stocks not included in the index) your assessment becomes slightly more difficult and prone to inaccuracy, but the process is exactly the same.

You’d need to calculate the correlation between your portfolio and the index on a daily (or more frequently) basis. And unless you’re planning on getting into the micro adjustments necessary to reflect even a static basket of stocks (and I assume you may add and delete as time passes) your options leg is going to get out of whack.

All of this is in addition to the initial hurdle of deciding how much cover or insurance you want. You could make a thesis out of just one trade, but I suspect, a rough guide is all that’s necessary should you choose to go down that route and Grantx has already suggested an example scenario that would meet your needs in principle (he must have done that by accident because it was quite good).

I thought I was pretty risk averse, but your caution, diligence and efforts in protecting your portfolio leaves me thinking my risk management is positively buccaneer!

Blinking heck. I've just realised this was Soooooo...far above my head - you two were having a skirmish and I hadn't realised.

Chaps - thanks for your input (seriously) but don't fall out on my behalf!

Tony - risk averse - maybe. But my principle is to hold a much larger portfolio than I would have without the "hedge". One where I wouldn't sleep without it

UTB

 

[Jack o'Clubs]

Blades, I'm fascinated by your portfolio's outperformance of the index on the upside, but correlation with it on the downside.

Did this hold out during the July/August market wobble?

I rather discovered the imperfections of my index hedging during that period - my portfolios were about twice as volatile as the indices I was hedging against both on the way down, and the way back up.

Did yours behave as expected during the period? It might not have been a 'black swan' but it was a pretty decent dip.

 

[TheBramble]

- you two were having a skirmish and I hadn't realised.

Me and grantx don't skirmish - we dance. Toe to toe...

 

[the blades]

Blades, I'm fascinated by your portfolio's outperformance of the index on the upside, but correlation with it on the downside.

Did this hold out during the July/August market wobble?

I rather discovered the imperfections of my index hedging during that period - my portfolios were about twice as volatile as the indices I was hedging against both on the way down, and the way back up.

Did yours behave as expected during the period? It might not have been a 'black swan' but it was a pretty decent dip.

It did wonderfully well for me in July, and terribly in August.

The increased correlation thing is just textbook speak in reality. The hedge takes some of the sting out, most of the time.

I currenlty use 23(!) systems (and currently 126 stocks!!! and relative strength over different periods is a common (ish) theme. The price you pay for general outperformance is, IMHO, getting stung when the market has a shock.

If it downturns (bear market), your portfolio rolls and is refreshed by new stocks, robust to the new conditions. That's another theory!

Quite a few of my systems are less RS based as I'm looking at ways to make my portfolio more robust to the shocks, without loss of performance.

Jack - do you hold a permanent hedge, or try and time it?

I've tried timing the market - reducing my hedge when a system says buy ('m still trying ) but with much less success than my long side.

UTB

 

[Jack o'Clubs]

I currenlty use 23(!) systems...

Jack - do you hold a permanent hedge, or try and time it?

I've tried timing the market - reducing my hedge when a system says buy ('m still trying ) but with much less success than my long side.

UTB

23 systems I have problems enough keeping on top of three

God, market timing. That opens a whole new can of worms. Yes I try and time the hedge, but this thread has got me thinking about that.

Basically I run a simple market indicator (my own, but it's just MA based) which gives a bullish / neutral to cautious / bearish reading. If bullish then no hedge, if bearish then 100% hedge. In the middle a 50% hedge. This is all using index future shorts so the percentages are never exact, as you've noted. That sounds fine in theory, but in practice I know that the indicator wouldn't make money if I traded it as a stand alone - too basic, so on what basis is it a good idea for hedging? A hedge relying on timing is no different to just trading the index, really. So am I better adopting a Blades type permanent hedge. Hmm - worried about giving up the 6-7% average market performance that way. Writing calls or buying puts on individual stocks would be the best way forward, but too much of my portfolio is mid- or small-cap so there's no market.

 

[grantx]

Nassim Bramble,

I understand exactly what you’re saying, and I can’t dispute any point. Our difference is in interpretation of objectives.

UTB,

“Outperform the index by 25%”. If you’re holding 126 stocks (are you a market-maker?),and you’re point of the reference is the FTSE 100, then obviously there will be a lack of correlation.

If an index constituent is perfected correlated, it has beta (factor) of 1. This means if the index moves up or down by say, 5% the stock will do likewise. I would guess your outperformance is due to stocks having a beta greater than 1, for example, 1.5.

This means if the index rises 10%, your stock will gain 15%, ie it will outperform. However, if the index falls 10%, your stock will lose 15%. As you imply, your system has worked thus far in a bull market, but be aware of your exposure in a bear market: “The price you pay for general outperformance is...getting stung when the market has a shock.”

Grant.

 

[the blades]

Nassim Bramble,

I understand exactly what you’re saying, and I can’t dispute any point. Our difference is in interpretation of objectives.

UTB,

“Outperform the index by 25%”. If you’re holding 126 stocks (are you a market-maker?),and you’re point of the reference is the FTSE 100, then obviously there will be a lack of correlation.

If an index constituent is perfected correlated, it has beta (factor) of 1. This means if the index moves up or down by say, 5% the stock will do likewise. I would guess your outperformance is due to stocks having a beta greater than 1, for example, 1.5.

This means if the index rises 10%, your stock will gain 15%, ie it will outperform. However, if the index falls 10%, your stock will lose 15%. As you imply, your system has worked thus far in a bull market, but be aware of your exposure in a bear market: “The price you pay for general outperformance is...getting stung when the market has a shock.”

Grant.

Grant,

I hedge against the Russell, S&P, Nas, CAC, DAX, FTSE. In reality I've overdone it and will narrow it to The FTSE and the Russell. The futures argument pushed me off the fence on this one.

You make valid points, but high RS / momentum stocks aren't simply high beta stocks, are they?

I expect underperformance when the market has a shock (ie a pullback). I fully "expect" to outperform a bear market.

Like I say - The theory tests out in a bear market and I've outperformed the theory in a Bull market. I can only hope, and also keep developing my strategies to cope for an inevitable (isn't it?) bear market.

Cheers,
UTB

 

[the blades]

. Hmm - worried about giving up the 6-7% average market performance that way.

JOC, for me the choice is;

a)23% return, 5% Drawdown
b)30% return, 20% Drawdown

I'd go for portfolio a with 2X margin.

Cheers,
UTB

 

[BSD]

Your aims are met by the fundamentals with no need to venture into the realms of gamma neutral/vega positive cluster regression (I just made that up).

Lol, I am nursing a bit of a hangover must admit, but it got instantly worse when I read the first part of that sentence. Thank God for the second part in brackets, I seriously thought I was losing it ;-)

 

[the blades]

Lol, I am nursing a bit of a hangover must admit,;-)

Lovely. It's not just me that suffers 'em well into the day then?

UTB

 

[BSD]

Lovely. It's not just me that suffers 'em well into the day then?

UTB

Thursday nights out are good, different crowd than weekends.

Bloody marvelous

hangover part isn't necessarily though

 

[the blades]

Thursday nights out are good, different crowd than weekends.

Bloody marvelous

hangover part isn't necessarily though

Mine was from Wednesday!. Actually, I think I'm ill. I don't think the wife agrees, but a gallon of Stella will sort it out tonight

UTB

 

[BSD]

I don't think the wife agrees, but a gallon of Stella will sort it out tonight

UTB

Prost !

 

[Jack o'Clubs]

I was actually looking for something completely different when the wonderful world of the internet threw this up, and I thought of you guys

http://www.rupissed.com/hangoverintensity.html

 

[BSD]

http://www.rupissed.com/hangoverintensity.html

LOL !

Time for a

I think

 

[Spam Man]

LOL !

Time for a

I think

A cup of tea? I think not my friend. It's time to indulge in God's great gift of BOOZE.

By the way Mr. Blades, sorry for not replying sooner but in answer to your question - Yes, you will miss out on interest on short stock sale proceeds under 50k with IB unless you use an EFP - http://www.interactivebrokers.com/en/trading/pdfhighlights/PDF-ExchPhysical.php?ib_entity=uk . They seem to be A Bloody Good Idea, but complex (I'm still in the process of getting my head round them), so I'd save this link for next week if I were you.

 

[BSD]

A cup of tea? I think not my friend. It's time to indulge in God's great gift of BOOZE.

Ah. Good idea. Have to wait till it's dark tho according to Rule No.1.

 

[the blades]

A cup of tea? I think not my friend. It's time to indulge in God's great gift of BOOZE.

By the way Mr. Blades, sorry for not replying sooner but in answer to your question - Yes, you will miss out on interest on short stock sale proceeds under 50k with IB unless you use an EFP - http://www.interactivebrokers.com/en/trading/pdfhighlights/PDF-ExchPhysical.php?ib_entity=uk . They seem to be A Bloody Good Idea, but complex (I'm still in the process of getting my head round them), so I'd save this link for next week if I were you.

Cheers Mr Spam. I'll let the Stella wear off as I'm slow at the best of times! I will have a look though.

UTB

 

[the blades]

I was actually looking for something completely different when the wonderful world of the internet threw this up, and I thought of you guys

http://www.rupissed.com/hangoverintensity.html

you're helpful in so many ways good sir!

I've just found out why I feel better when I get pissed (well, top off the Stella) on Gin. It's a pity it's £3.10 for a drink that lasts me 5 minutes!

Further reading required

Oh, and my hedge isn't working again

UTB

 

[grantx]

UTB,

I thought a Sheffield cocktail would be your preferred tipple: pint of bitter with a pickled onion. Bramble's is Campari and lemonade or Dubonnet - but from a dirty glass to make him look tough.

Grant.