Friday, March 02, 2007

Hedge Time

Make sure you hedge your portfolio if you're a trader of stocks. A trader would be defined as one who buys and sells stocks using a holding period of less than 6 months. Long term investors just see this as a healthy pullback and a suitable time to add to winning positions as fundies have not changed just fear in the market.

Ways to hedge your portfolio....
If trading an individual stock, you could always buy cheap put options which are out of the money dated out 3-5 months just to hedge the short term losses that will occur if the fear on Wall Street Continues to rise and stocks get temporarily knocked down.

One could buy Index options such as the S & P 500 Index, and use SPY Puts.

There is always the small cap route which seems to take more of a punishing while the market corrects, and this would constitute buying IWM, or Russell 2000 Put Options.

Correct my opinion if you disagree but when trading stocks outright, you're limited to the ways you can protect yourself from fall outs. For example, you buy stock XYZ and it's trotting along nicely in an upward trend, and yet you have no downside protection, so you decide to short sell the same're counteracting the gains with losses, because when one goes up the other goes down on a 1:1 basis, with no leverage involved.

The whole point of using stock options is to provide cheap risk management, while simultaneously using leverage in a productive manner. It serves it's purpose well.

Of course there are inverse stock relations of certain sectors that you could use to hedge, such as buying gold if the dollar is weak, if the stock market is down you could always buy (LVLT) which is levered to the bond market which almost 90% of the time trades inversely to the market conditions.

Some people recommend playing the Futures market to hedge a portfolio. I would stray from this idea, I've learned from personal experience that the Futures market can be very volatile and cut-throat. It's trading a Ferrari paced financial vehicle where only the quick survive in the short term and only the patient survive in the longer term. I must say that you have to have a large threshold hold while trading Futures and what I mean by that is, with Global Futures there is a parameter you can set to where if you lose more than a certain amount in 1 day all of your positions will be liquidated, same goes for gains, but hey who would want to cash out if they were already up to their neck in green? One's portfolio with even 5-10 contracts could easily fluctuate $1,000's of dollars each day. Just something to ponder...

I've decided to take the plunge and buy the dip. I'm buying longer dated S&P SPY Calls. A proper hedge would be to sell short term out of the money call options, or even buy cheap March 2007 Put options to cover your butt in case of another massive sell off, who knows what this market will can only be prepared....just like the hedge funds who had $VIX Call options and made $100,000's (hundreds of thousands of dollars) in 1 day while everyone else is bleeding like a fish...
More To Come,