Hedging with an ETF

Hedging a portfolio is often important in order to protect gains – to protect against downside moves caused by a variety of catalysts and/or events (like NFP). The past few weeks I have documented numerous comments and information regarding the use of ETFs to hedge and thought I would throw in my 2 cents.

One of the key issues with this approach of using an ETF as a hedge is that many are simply not appropriate for a hedge – a hedge that is meant to be held for longer than 1 day. So what is the correct approach if you want a hedge beyond this 1 day timeframe?

I use options, either as an independent trade or in conjunction with stock, and have found this to be the right approach for me. Here is what I put out on twitter on Thursday, April 5 2012:

Here is my case for this approach, and why it works over a longer timeframe to encompass an upcoming event/catalyst:

  • A fixed cost. You know what you have invested in the trade, the max loss for the hedge. Quite a value here for a quarter, that doesn’t buy much these days.
  • This hedge is already ITM (In the Money) so you are already participating in a gain.
  • You know the timeframe for the hedge so you can plan accordingly. April 21 is the expiration for this trade so this hedge can be taken off at any point up to then – to book any gains that exist.
  • It is important to note that the gain is capped at the $10 strike so the hedge would cease to provide value at that point.

Enjoy your Good Friday.

 

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