Macro Hedging

[valuecfa]

Despite never turning a profit on a US equity market hedge, i haven't yet learned my lesson. As they say...the best hedge is cash.

 

I'm tempted to speculate with some very minor macro hedging positions if valuations on the US market continue to rise ~ another 5-10%. After some thought, I'm thinking of targeting the Russell 2000. Anyone have insightful thoughts on shorting the index vs the index's puts, given costs/risks of both?

 

Obviously puts loss is limited vs a short position, but puts are a tad expensive at the moment..

[stahleyp]

Personally, I've never hedged with the index to any great degree.

 

Speaking of index puts, anyone remember how they were being priced in 2006-2007?

[ERICOPOLY]

The at-the-money may seem like you are throwing away the premium, but if you are truly hedging and not speculating then you will recover that premium after writing covered at-the-money puts after the market drops.

 

Then the premium on your covered put decays by expiry.

 

Now, if the market rallies once again by expiry you might end up with no profit from the short position.  But again, was this for hedging or for speculation?  If for hedging, then you should be happy that if the index stays down your profit is intact.  And if the index rises, your other positions do too.

 

Volatility rises as the market crashes, so don't worry about being able to recover your premium.

[ERICOPOLY]

valuecfa,

Given that you are comfortable with the downside of MBI below a given point, I think you could do well writing out-of-the-money MBI puts and using the proceeds to purchase at-the-money index puts.

 

I mention MBI because of your background with the company, as well as it's very high volatility premium relative to what the premium is for the index.

 

Worst case, no gain/no loss.  Best case, market drops and you make money.  I'm assuming you wouldn't care that much about the risk of getting assigned MBI at $10 or $8.

 

Plus, it seems likely that MBI's premium will continue to decline in this post-uncertainty world for MBI.  Right after the pop, I wrote $8 MBI 2014 puts for $1.15.  Already they're down to about 70 cents.  It should continue to suffer rapid premium decay.