Cheapest way to buy downside protection

[Orange]

Agreed. Always invert. Don't buy insurance, sell stuff.

 

Aren't you already inverting by not doing the obvious thing (selling a relatively cheap holding in an expensive market)? IMO "Invert, always invert" is overhyped and used whenever possible without really saying much.

 

I thought it was appropriate: somebody is asking about purchasing downside protection but maybe could consider the inverse (selling upside participation) to achieve the same goal. But feel free to ignore the quote :)

 

Why would you think that selling premium is the consequence of an "always invert" mindset, when option premiums are at 70% of their historical average?

 

It seems to me you would rather parrot back the overused catchphrases of your favorite investor, rather than actually thinking deeply about the situation.

[writser]

I didn't mean selling derivatives but selling equity. I'm sorry if I didn't make myself clear. I will avoid overused catchphrases in the future. Again, sorry.

[ukvalueinvestment]

I have done no work on it whatsoever, but I would think that Fairfax would be the perfect way to pick up cheap "protection", given that they own a tonne of what you want - options protecting the downside.

[Uccmal]

 

 

Why would you think that selling premium is the consequence of an "always invert" mindset, when option premiums are at 70% of their historical average?

 

 

Orange, What do you mean by this.  Which options?  calls, puts?

[Orange]

I didn't mean selling derivatives but selling equity. I'm sorry if I didn't make myself clear. I will avoid overused catchphrases in the future. Again, sorry.

 

Eh, don't worry. I'm being harsh. Too much coffee. Cheers, as they say.

[Orange]

 

 

Why would you think that selling premium is the consequence of an "always invert" mindset, when option premiums are at 70% of their historical average?

 

 

Orange, What do you mean by this.  Which options?  calls, puts?

 

I was speaking generally of the VIX, and put options, since this is a discussion of protection. Of course, vol varies from security to security, and some may be expensive right now.

 

But, the VIX is below 14 today, and the historical average is around 20, I believe. Hence premiums are 70% of their historical average.

[Uccmal]

Thanks, Orange... will have to research further. 

[bargainman]

https://www.cboe.com/micro/doom/doomquickreference.aspx

 

[no_free_lunch]

Since options are cheap, you can also buy leap calls and keep a large cash balance.  For instance, if you can find some leaps that you think will triple to quadruple over the next couple of years, then you can put 10% in the leaps and hold 90% cash.  Worst case you are down 10% but can now deploy the cash in a bear market.  If the leaps hit you are up 20 to 30%.  It won't be insane returns but not bad for the amount of risk you are taking.

[frommi]

Of course, vol varies from security to security, and some may be expensive right now.

 

I did a lot of brainwork in january this year on the best way to protect the portfolio, my conclusion was that its selling slightly OTM calls against stocks that have a high implied volatility and are highly valued. TSLA, FB come to my mind at the moment. That way you have time and the probabilities working on your side. You won`t get rich in case the stock market collapses, but i don`t think a real crash with -40 or -50% has a high chance of happening in the current environment.

I will take this route next month until september/october to additionally factor the seasonal/election cycle statistics in. This is kind of like a summary of all statistical relevant market anomalies baked into one trading decision.

[PatientCheetah]

Since options are cheap, you can also buy leap calls and keep a large cash balance.  For instance, if you can find some leaps that you think will triple to quadruple over the next couple of years, then you can put 10% in the leaps and hold 90% cash.  Worst case you are down 10% but can now deploy the cash in a bear market.  If the leaps hit you are up 20 to 30%.  It won't be insane returns but not bad for the amount of risk you are taking.

 

Leaps make sense for large liquid stocks that have low volatility. Otherwise, the total cost of holding leaps gets expensive particularly if the stocks pay dividend. What you guys think of having a wide 15-20% stop loss order? In a way, it is similar to a synthetic put.

[no_free_lunch]

xerodex,

 

If you are holding something and it goes down 15-20%, why would you want to sell it?  If it was a good deal now, it's an even better deal when it's down. 

[rkbabang]

Since options are cheap, you can also buy leap calls and keep a large cash balance.  For instance, if you can find some leaps that you think will triple to quadruple over the next couple of years, then you can put 10% in the leaps and hold 90% cash.  Worst case you are down 10% but can now deploy the cash in a bear market.  If the leaps hit you are up 20 to 30%.  It won't be insane returns but not bad for the amount of risk you are taking.

 

That sounds similar to the strategy Nassim Taleb talks about in Antifragile.  He advocates keeping 90% in cash and positioning the remaining 10% to take advantage of black swans. 5% in way out of the money calls and 5% in way out of the money puts.

 

[SharperDingaan]

"That sounds similar to the strategy Nassim Taleb talks about in Antifragile.  He advocates keeping 90% in cash and positioning the remaining 10% to take advantage of black swans. 5% in way out of the money calls and 5% in way out of the money puts."

 

The less risky version of this is to hold long term warrants, or higher quality juniors, instead of puts/calls. The kicker, is what happens after some of those bets hit the jackpot. ie: After 2-3 wins, that former 100K in warrants/juniors is now 500K ... & a very different animal. Not scalable.

 

SD

[no_free_lunch]

"That sounds similar to the strategy Nassim Taleb talks about in Antifragile.  He advocates keeping 90% in cash and positioning the remaining 10% to take advantage of black swans. 5% in way out of the money calls and 5% in way out of the money puts."

 

The less risky version of this is to hold long term warrants, or higher quality juniors, instead of puts/calls. The kicker, is what happens after some of those bets hit the jackpot. ie: After 2-3 wins, that former 100K in warrants/juniors is now 500K ... & a very different animal. Not scalable.

 

SD

 

Sounds like a good problem to have.

[PatientCheetah]

xerodex,

If you are holding something and it goes down 15-20%, why would you want to sell it?  If it was a good deal now, it's an even better deal when it's down.

 

I absolutely agree if the decline is due to market swings. Now it begs the question that why can't we make the same argument for the overall market?

[twacowfca]

https://www.cboe.com/micro/doom/doomquickreference.aspx

 

That's a fallacious comparison showing that the cost/ benefit of buying a Lehman CDS or a deep OTM 6 month Lehman stock put and holding each for 6 months until the Lehman stock went to zero and the  CDS payout got triggered would have produced about the same large gain.

 

The contrafactual refutation is this: What if it had taken two years instead of six months for Lehman to have gone to zero?  In that event, the cost of maintaining the payment to hold the CDS each additional six month period would have been the same as in the first six month period.  However, rolling over the put at the same strike price every six months after the price of the underlying stock went down, would become increasingly much pricier as the difference between the strike price of the put and the price of the underlying stock narrowed.  Also, the implied volatility of the value of the put likely would have increased greatly as the price of the stock declined sharply, adding to the cost of maintaining the put over two years.

[meiroy]

Since options are cheap, you can also buy leap calls and keep a large cash balance.  For instance, if you can find some leaps that you think will triple to quadruple over the next couple of years, then you can put 10% in the leaps and hold 90% cash.  Worst case you are down 10% but can now deploy the cash in a bear market.  If the leaps hit you are up 20 to 30%.  It won't be insane returns but not bad for the amount of risk you are taking.

 

That sounds similar to the strategy Nassim Taleb talks about in Antifragile.  He advocates keeping 90% in cash and positioning the remaining 10% to take advantage of black swans. 5% in way out of the money calls and 5% in way out of the money puts.

 

Remind us what was his returns as an investor?  I rather go with those who have done 40% over a long period of time (which include bear markets or crashes) than those who have hardly done much or maybe even just 20%.

 

If someone is scared that in the next year it's possible to have a 50%+ meltdown they probably shouldn't be investing in equities anyhow (I hear growing grapes is much more relaxing). Seriously. And hedging for a 10% or 20% down? I can understand someone might do that if they are in the business of investing but for those of us who are only in the investing part, why bother?

 

[no_free_lunch]

xerodex,

If you are holding something and it goes down 15-20%, why would you want to sell it?  If it was a good deal now, it's an even better deal when it's down.

 

I absolutely agree if the decline is due to market swings. Now it begs the question that why can't we make the same argument for the overall market?

 

Sorry, I just don't quite understand what you are trying to say here.  ???

[no_free_lunch]

Since options are cheap, you can also buy leap calls and keep a large cash balance.  For instance, if you can find some leaps that you think will triple to quadruple over the next couple of years, then you can put 10% in the leaps and hold 90% cash.  Worst case you are down 10% but can now deploy the cash in a bear market.  If the leaps hit you are up 20 to 30%.  It won't be insane returns but not bad for the amount of risk you are taking.

 

That sounds similar to the strategy Nassim Taleb talks about in Antifragile.  He advocates keeping 90% in cash and positioning the remaining 10% to take advantage of black swans. 5% in way out of the money calls and 5% in way out of the money puts.

 

Remind us what was his returns as an investor?  I rather go with those who have done 40% over a long period of time (which include bear markets or crashes) than those who have hardly done much or maybe even just 20%.

 

If someone is scared that in the next year it's possible to have a 50%+ meltdown they probably shouldn't be investing in equities anyhow (I hear growing grapes is much more relaxing). Seriously. And hedging for a 10% or 20% down? I can understand someone might do that if they are in the business of investing but for those of us who are only in the investing part, why bother?

 

 

There can come a point though, where you want to protect yourself against inflation or still want to catch some of the upside of a strong market.  I increasingly just think of things in terms of inflation adjusted returns (as opposed to returns relative to the market) and just want that number to be positive.  It is pretty hard to get positive inflation adjusted returns without some equity exposure which quickly leads to decisions on how to hedge.

 

Also, it's really not that uncommon to hedge.  Einhorn, Soros, Baupost, Loeb, they all hedge in some form and still pull out amazing results.

 

I don't think anyone is talking about hedging for a 10 or 20% down market.

[yadayada]

what I think is best is just researching your ideas thoroughly. Buy shit that is adding value and somewhat recession proof and buy it cheap. And you can check if its recession proof by looking at how they did in 08-09. Dont buy things you dont understand, if you cant really answer with reasonable certainty where they will be 5-6 years from now then dont buy it. And dont constantly look at how much you are up and down.

 

If by downside you mean volatility, that should only really be an issue if you run a fund for people who have no clue what valueinvesting really is.

 

i think the biggest problem with most investors is that they are too results oriented. That is why buffett keeps repeating the same stuff over and over again. It is like training in the army, when shit hits the fan you can automatically do what is right and wont spazz out. Because it has been drilled in so much.