Liquidity Risk and Puts

[Phaceliacapital]

Hi all,

 

I had a thought question for those managing large PA/funds, or maybe all portfolios where liquidity risk might play a significant role. How actively do you consider and assess the liquidity risk your portfolio is running?

 

And in this thought exercise, do you consider buying put options on an index as a (partial) hedge for liquidity risk?

 

My 2 cents is that liquidity risk is definitely one of the more difficult risks to mitigate, as it is almost impossible to quantify. I think that having some kind of contract (owning put options) that gives the right to sell something (an index) at a certain price helps mitigate the risk, even if you do not fully own the index itself.

 

Happy to hear your thoughts/comments!

 

 

[twacowfca]

Hi all,

 

I had a thought question for those managing large PA/funds, or maybe all portfolios where liquidity risk might play a significant role. How actively do you consider and assess the liquidity risk your portfolio is running?

 

And in this thought exercise, do you consider buying put options on an index as a (partial) hedge for liquidity risk?

 

My 2 cents is that liquidity risk is definitely one of the more difficult risks to mitigate, as it is almost impossible to quantify. I think that having some kind of contract (owning put options) that gives the right to sell something (an index) at a certain price helps mitigate the risk, even if you do not fully own the index itself.

 

Happy to hear your thoughts/comments!

 

Yes. Buying puts on broad indexes is a way to hedge liquidity risk because sales of the more liquid, large stocks is a quicker way for funds to raise money than by selling less liquid stocks in a stressed environment. Therefore, broad indexes aren't immune to big sell offs in panics.  Puts on broad indexes are generally less pricey than puts on less liquid stocks or indexes, and may have tax advantages in the US.