Risk – Page 127 – Slope of Hope with Tim Knight

Slope of Hope Blog Posts

Slope initially began as a blog, so this is where most of the website’s content resides. Here we have tens of thousands of posts dating back over a decade. These are listed in reverse chronological order. Click on any category icon below to see posts tagged with that particular subject, or click on a word in the category cloud on the right side of the screen for more specific choices.

Hedging Update — ETFs

By Dpinsen - 15 years ago (15, Jul 2011 8:49:51 AM)

The Chicago Board Options Exchange Market Volatility Index (VIX) rose 4.47% Thursday, to close at 20.80. The table below shows the costs, as of Thursday's close, of hedging 18 of the 20 most actively-traded ETFs against greater-than-20% declines over the next several months, using the optimal puts for that. First, a reminder about what optimal puts mean in this context, and why I've used 20% as a decline threshold.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web, and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own, and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones (there's an example of this, with screen shots, in this article).

Decline Thresholds

You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). The idea for a 20% threshold comes, as I've mentioned before, from a comment fund manager John Hussman made in a market commentary in October 2008:

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

Essentially, 20% is a large enough threshold that it reduces the cost of hedging but not so large that it precludes a recovery. When hedging, cost is always a concern, which is where optimal puts come in.

How Costs Are Calculated

To be conservative, Portfolio Armor calculated the costs below based on the ask prices of the optimal put options. In practice, though, an investor may be able to buy some of these put options for less (i.e., at a price between the bid and the ask).

Why There Were No Optimal Puts for TZA and FAZ

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with the Direxion Small Cap Bear 3X (TZA) and the Direxion Daily Financial Bear 3X (FAZ). As of Thursday's close, the cost of protecting against greater-than-20% declines in those ETFs over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for them.

Hedging costs as of Thursday

The data in the table below is as of Thursday's close. The ETFs are listed in order trading volume Thursday, with the most actively-traded name (SPY) at the top.

Symbol	Name	Cost of Protection (as % of position value)
SPY	SPDR S&P 500	1.80%*
XLF	Financial Select Sector SPDR	3.23%*
QQQ	QQQ Trust	2.68%*
IWM	iShares Russell 2000 Index	2.93%*
SLV	iShares Silver Trust	5.05%*
EEM	iShares MSCI Emerging Markets	2.80%*
EWJ	iShares MSCI Japan	1.89%*
FAS	Direxion Financial Bear 3X	17.31%*
SDS	ProShares Ultra Short S&P 500	4.12%*
VWO	Vanguard MSCI Emerging MKTS	3.48%*
EFA	iShares MSCI EAFE Index	3.12%*
TZA	Direxion Small Cap Bear 3X	No Optimal Puts
XLE	Select Sector SPDR — Energy	3.10%*
FXI	iShares FTSE China 25 Index	2.94%*
XLI	Industrial Select Sector SPDR	2.03%*
SSO	ProShares Ultra S&P 500	7.30%*
GLD	SPDR Gold Shares	0.43%*
SMH	Semiconductor HOLDRs	4.87%*
GDX	Market Vectors Gold Miners	4.03%*
FAZ	Direxion Daily Financial Bear 3X	No Optimal Puts

*Based on optimal puts expiring in January, 2012.

QE Correlation

By Tim Knight - 15 years ago (13, Jul 2011 11:36:01 AM)

Springheel Jack’s post yesterday (UUP Breaks Up) got me thinking about the correlation between the dollar (UUP) and the S&P. Apparently, Tim was thinking along the same lines this morning with his Forex post (The Euro and the ES). I am trying to look at the long-term picture of what/how the various Fed “efforts” have moved the market. The story of [Ben turns on the presses = goosed market] is already known, but I’m looking to determine the extent of the correlation during the different periods.

Quick history: In late November 2008, the Fed started buying $600 billion in Mortgage-backed securities. By March 2009, it held $1.75 trillion of bank debt, MBS, and Treasury notes, and reached a peak of $2.1 trillion in June 2010. After a relatively short break and a coincidental 20% drop in the market as QE1 ended, the Fed decided to renew quantitative easing because “the economy wasn't growing robustly”. Its goal was to keep holdings at the $2.054 trillion level by replacing maturing debt. To maintain that level, the Fed bought $30 billion in 2-10 year Treasury notes a month. In November 2010, the Fed announced it would increase quantitative easing, buying an additional $600 billion of Treasury securities by the end of the second quarter of 2011.

The correlation between UUP and the SPX since March 2007 is -.35; not exactly investment-worthy in my book. However, I broke out the correlation during the aforementioned periods:

Pre-QE -.27

Since QE1 started -.83

During QE1 -.68

Between 1&2 -.94

During QE2 -.67

A couple things jumped out at me here… First, that since QEs started, the market now dances to the Fed’s tune (duh); but more importantly, the correlation data says it is by a significant- and therefore investable- amount. Second, the -.94 is a surprisingly extreme number… it was only for a 4 month period, but I cannot say with any certainty why. I would imagine that by not knowing if there was going to be a QE2, traders followed Forex more closely. On the other hand, the Forex and equity markets could have been reacting to, as I recall, a tremendous amount of chatter back then speculating that QE2 was coming.

Now that QE2 has “ended,” I bring up these points because in a speech to Congress, Bernanke said the Fed is preparing for another round of Treasury bond buying (y’know- just in case this “soft patch” isn’t as temporary as Washington would like voters to believe) and the QE3 chatter seems to have increased (e.g., Why Bernanke And Pals Will Soon Need a New Pair of Pants, Stocks Rise Amid Hopes for Further Stimulus).

I’m neither an economist nor a political commentator, but with an election next year, I think they will throw everything they have at keeping the market propped-up… including some creative way to implement QE3. So, if recent history is any indication, we should now be in a period similar to the one between QE1 and QE2; where there is a high inverse-correlation between the dollar and the market.

Hedging Update — Stocks

By Dpinsen - 15 years ago (13, Jul 2011 5:55:06 AM)

The Chicago Board Options Exchange Market Volatility Index (VIX) ticked up 8.05% Tuesday to close at 19.87. The table below shows the costs, as of Tuesday's close, of hedging 19 of the 20 of the most actively-traded stocks against greater-than-20% declines over the next several months, using the optimal puts for that.

Comparisons

For comparison purposes, I've also added the costs of hedging the SPDR S&P 500 Trust ETF (SPY), the SPDR Dow Jones Industrial Average ETF (DIA) and the Nasdaq 100-tracking ETF PowerShares QQQ Trust ETF (QQQ) against the similar declines. First, a reminder about what optimal puts mean in this context and why I've used 20% as a decline threshold.

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones (there's an example of this, with screenshots, in this article about hedging against a US default with puts on TLT).

Decline Thresholds

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

How Costs Are Calculated

Why There Were No Optimal Puts for RADS

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with Radiant Systems Inc. (RADS). As of Tuesday, the cost of protecting against a greater-than-20% decline in that stock over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for it.

Hedging Costs as of Tuesday's close

The data in the table below is as of Tuesday's close. After the three ETFs listed for comparison purposes, the NYSE stocks are listed in order of their share volume in Tuesday's trading, with the most actively traded stock (MI) listed first; the Nasdaq stocks are listed in a similar order, with the most actively traded Nasdaq stock (NWSA) listed first.

Symbol	Name	Cost of Protection (as % of position value)
	Comparison Index ETFs
SPY	SPDR S&P 500	1.71%*
DIA	SPDR Dow Jones Industrial Avg	1.55%*
QQQ	PowerShares QQQ Trust	2.49%*
	NYSE Stocks
BAC	Bank of America Corporation	5.78%*
NLY	Annaly Capital Management	1.83%*
F	Ford	3.58%*
GE	General Electric Company	3.43%*
C	Citigroup Inc.	3.99%*
PFE	Pfizer Inc.	2.95%*
AMD	Advanced Micro Devices, Inc.	9.64%*
MGM	MGM Resorts International	12.2%*
AA	Alcoa, Inc.	5.03%*
JPM	JP Morgan Chase & Co.	3.15%*
	Nasdaq Stocks
NWSA	News Corporation	6.51%*
CSCO	Cisco Systems, Inc.	4.17%*
QQQ	PowerShares QQQ	2.49%*
INTC	Intel Corporation	2.94%*
SIRI	Sirius XM Radio Inc.	11.0%*
MSFT	Microsoft Corporation	2.49%*
ORCL	Oracle Corp.	3.56%*
RADS	Radiant Systems Inc.	No Optimal Puts At This Threshold
MU	Micron Technologies	12.1%*
AMAT	Applied Materials Inc.	4.43%*

*Based on optimal puts expiring in January, 2012.

Hedging Update — ETFs

By Dpinsen - 15 years ago (08, Jul 2011 10:35:51 AM)

The Chicago Board Options Exchange Market Volatility Index (VIX) dropped 2.39% Thursday, to close at 15.95. The table below shows the costs, as of Thursday's close, of hedging the 20 most actively-traded ETFs against greater-than-20% declines over the next several months, using the optimal puts for that. First, a reminder about why I've used 20% as a decline threshold and what optimal puts mean in this context.

Optimal Puts

Decline Thresholds

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

How Costs Are Calculated

Hedging costs as of Thursday

The data in the table below is as of Thursday's close. The ETFs are listed in order trading volume Thursday, with the most actively-traded name (SPY) at the top.

Symbol	Name	Cost of Protection (as % of position value)
SPY	SPDR S&P 500	1.10%*
IWM	iShares Russell 2000 Index	2.25%*
EWJ	iShares MSCI Japan	1.78%*
EEM	iShares MSCI Emerging Markets	2.25%*
XLF	Financial Select Sector SPDR	1.92%*
XLI	Industrial Select Sector SPDR	1.85%*
XLE	Select Sector SPDR — Energy	2.10%*
EFA	iShares MSCI EAFE Index	2.03%*
EWZ	iShares MSCI Brazil Index	3.86%*
USO	United States Oil	3.52%*
XLK	Technology Select Sector SPDR	1.39%*
SMH	Semiconductor HOLDRs	2.42%*
XLB	Materials Select Sector SPDR	2.66%*
EWT	iShares MSCI Taiwan Index	2.61%*
IYR	iShares Dow Jones Real Estate	1.92%*
XLU	Utilities Select Sector SPDR	0.97%*
XLY	Consumer Discretionary SPDR	1.59%*
XLV	Health Care Select SPDR	1.11%*
XLP	Consumer Staples Select SPDR	0.75%*
TLT	iShares Barclays 20+ Yr. Treas.	0.74%*

*Based on optimal puts expiring in January, 2012.

Hedging Update — Stocks

By Dpinsen - 15 years ago (06, Jul 2011 10:08:00 AM)

The Chicago Board Options Exchange Market Volatility Index (VIX) ticked up 1.2% Tuesday to close at 16.06. The table below shows the costs, as of Tuesday's close, of hedging 19 of the 20 of the most actively-traded stocks against greater-than-20% declines over the next several months, using the optimal puts for that.

Comparisons

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task. With Portfolio Armor (available on the web and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own and the maximum decline you're willing to risk (your threshold). Then the app uses an algorithm developed by a finance academic to sort through and analyze all of the available puts for your position, scanning for the optimal ones (there's an example of this, with screenshots, in this article about hedging against a US default with optimal puts on TLT).

Decline Thresholds

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even … a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first few months of an advance (or even a powerful bear market rally).

How Costs Are Calculated

Why There Were No Optimal Puts for LVLT

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with Level 3 Communications (LVLT). As of Friday, the cost of protecting against a greater-than-20% decline in that stock over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for it.

Hedging Costs as of Tuesday's close

Symbol	Name	Cost of Protection (as % of position value)
	Comparison Index ETFs
SPY	SPDR S&P 500	1.23%**
DIA	SPDR Dow Jones Industrial Avg	1.22%**
QQQ	PowerShares QQQ Trust	1.98%**
	NYSE Stocks
MI	New M&I Corporation	5.06%**
BAC	Bank of America Corporation	5.91%**
ACN	Accenture, plc	2.35%**
F	Ford	4.68%**
GE	General Electric Company	2.68%**
C	Citigroup Inc.	3.43%**
S	Sprint Nextel Corporation	8.35%**
PFE	Pfizer Inc.	2.31%**
WFC	Wells Fargo & Co.	3.55%**
JPM	JP Morgan Chase & Co.	3.27%**
	Nasdaq Stocks
SIRI	Sirius XM Radio Inc.	11.0%**
CSCO	Cisco Systems, Inc.	3.89%**
MSFT	Microsoft Corporation	2.57%**
MU	Micron Technologies	12.1%**
INTC	Intel Corporation	2.67%**
LVLT	Level 3 Communications, Inc.	No Optimal Puts At This Threshold
BLUD	Immucor, Inc.	0.37%*
ORCL	Oracle Corp.	3.12%**
YHOO	Yahoo! Inc.	5.55%**
DELL	Dell Inc.	4.35%**

*Based on optimal puts expiring in December, 2011.

**Based on optimal puts expiring in January, 2012.