Best of the Week
Most Popular
1. Crude Oil and Water: How Climate Change is Threatening our Two Most Precious Commodities - Richard_Mills
2.The Potential $54 Trillion Cost Of The Fed's Planned Interest Rate Increases - Dan_Amerman
3.Best Cash ISA Savings for Rising UK Interest Rates and High Inflation - March 2018 - Nadeem_Walayat
4.Fed Interest Hikes, US Dollar, and Gold - Zeal_LLC
5.What Happens Next after February’s Stock Market Selloff - Troy_Bombardia
6.The 'Beast from the East' UK Extreme Snow Weather - Sheffield Day 2 - N_Walayat
7.Currencies Will Be ‘Flushed Down the Toilet’ Triggering a ‘Mad Rush into Gold’ - MoneyMetals
8.Significant Decline In Stocks On The Cards! -Enda_Glynn
9.Land Rover Discovery Sport Extreme Driving "Beast from the East" Snow Weather Test - N_Walayat
10.SILVER Large Specualtors Net Short Position 15 Year Anniversary - Clive_Maund
Last 7 days
Watch This Group Signal Stock Market Trend Changes - 22nd Mar 18
Stocks are Gapping Beneath the Trendline Support - 22nd Mar 18
Fed Action Casts Shadow on Bullish Case for Stocks - 22nd Mar 18
A Strong Economy and Weak Stock Market is Bullish for Stocks - 22nd Mar 18
Fed Raises US Interest Rates 25bp – Where Are We In The Stock Market Cycle? - 22nd Mar 18
Why Spotify Will Likely Surge During Its IPO - 22nd Mar 18
SY Police Arrest Woman for Blowing Trumpet at Sheffield Tree Felling Protest - 22nd Mar 18
Facebook: The Anti-Social Network Covert Data Gathering - 21st Mar 18
Additional Signs for Gold and Silver Amid Increasing FOMC Tension - 21st Mar 18
Credit Concerns In U.S. Growing As LIBOR OIS Surges to 2009 High - 21st Mar 18
Stock Markets Are Flat-to-lower Before the FOMC - 21st Mar 18
Will Powell’s Actions Pop Stock Market Perfection - 21st Mar 18
Economic Moral Hazards of the International Criminal Court - and Philippines Withdrawal - 21st Mar 18
Larry Kudlow vs. Vladimir Putin on Gold - 21st Mar 18
Trump Builds Economy and War Machine - 21st Mar 18
This Stock Market "Illusion" Can Destroy Once-Vibrant Portfolios - 21st Mar 18
Gold Short-term Pull Back in Progress - 20th Mar 18
Stocks Appear to be Under Pressure - 20th Mar 18
Time To Eliminate Your Wall Street Tax? - 20th Mar 18
The Beast from the East Snow, UK Roads Driving Car Accidents - 20th Mar 18
Can Bitcoin Price Rally Continue After Paypal Fake FUD Attack? - 19th Mar 18
2018 Reversal Dates for Gold, Silver and Gold Stocks - 19th Mar 18
This Tech Breakthrough Could Save The Electric Car Market - 19th Mar 18
Stocks Set to Open Lower, Should You Buy? - 19th Mar 18
The Wealth Machine That Rising Interest Rates Create Conflict With The National Debt - 19th Mar 18
Affiliate Marketing Tips and Network Recommendations - 19th Mar 18
Do Stocks Bull Market Tops Need Breadth Divergences? - 19th Mar 18
Doritos Instant £500 Win! Why Super Market Shelves are Empty - 19th Mar 18
Bonds, Inflation & the Market Amigos - 19th Mar 18
US Housing Real Estate Market and Banking Pressures Are Building - 19th Mar 18
Stock Market Bulls Last Stand? - 18th Mar 18
Putin Flip-Flops Like A Drunken Whore On Bitcoin Cryptocurrency Legalization - 18th Mar 18
How to Legally Manipulate Interest Rates - 18th Mar 18
Return of Stock Market Volatility Amidst Political Chaos and Uncertain Economy - 18th Mar 18
Bitcoin Price Trend Forecast, Paypal FUD Fake Cryptocurrency Warning - 17th Mar 18
Strong Earnings Growth is Bullish for Stocks - 17th Mar 18
The War on the Post Office - 17th Mar 18
GDX Gold Mining Stocks Fundamentals - 16th Mar 18
Nationalism, Not the Russians, got Trump Elected - 16th Mar 18
Has Bitcoin Bought It? - 16th Mar 18
Crude Oil Price – Who Wants the Triangle? - 16th Mar 18
PayPal Cease Trading Crypto Currency Bitcoin Warning Email Sophisticated Fake Scam? - 16th Mar 18
EUR/USD – Something Old, Something New and… Something Blue - 16th Mar 18

Market Oracle FREE Newsletter

Urgent Stock Market Message

How to Safely Hedge Your Stocks Portfolio in Uncertain Times

Portfolio / Learning to Invest Mar 08, 2013 - 03:08 PM GMT

By: Investment_U


David Eller writes: What a year 2013 has been. The S&P is up 6% and we’re 3% away from all-time highs. The Dow Jones broke through 14,000…

Can things get better from here? Can they even stay this good? Nobody knows where the markets will go, but there are ways to protect yourself and sleep easy at night.

Personally, I’m not a believer in short selling individual stocks. The deck is stacked against you. The Fed wants asset prices to increase, company management teams want stock prices to rise and sell-side investment analysts constantly prop up share prices of weak corporations. This is just too much to compete with when there is easier money to be made buying stock of good companies.

However, if you are concerned about protecting gains, short selling an index can be an effective way to lock in profits, without liquidating your portfolio. Why go to the trouble?

Let’s say you’re fully invested in The Oxford Club’s Oxford Trading Portfolio. This consists of 25 stocks in diverse industries. It could make sense to keep your positions on for tax purposes, to capture the dividends, or just because you think these stocks will outperform if the market sells off. How can you protect yourself?

Some methods are better than others, so we analyzed the five major pullbacks over the last three years to find the best ways to hedge. We also uncovered some useful takeaways that can help you protect your hard-won gains.

Shorting SPY isn’t an efficient hedge.

The first option that comes to mind is shorting the S&P 500 tracking stock, the SPY. It makes sense this would protect your downside on a one-for-one retreat in the S&P 500. But unfortunately, empirical evidence shows this isn’t the case.

According to the second table, the SPY only pulled back 88% of the decline. And in Table 1, it retraced a smaller percentage than the S&P in each of the five pullbacks. While it is possible to short the SPY to protect gains, it clearly isn’t efficient.

Buying VXX is like juggling chainsaws.

The most dangerous method may also be the most talked about. The financial press loves to discuss a fear gauge known as the VIX. If you time an investment in this security perfectly, you can see dramatic returns. During the market sell-off between April 2 and June 4 of 2012, the VXX returned 29% compared with a 9.6% drop in the S&P. It also increased by 3.8 times the pullback of the S&P 500 on average over the last five meaningful declines.

The returns are great… But in my opinion, investing in this security could be compared with juggling chainsaws. Your timing has to be perfect. If you had left the position on until June 20, the return would have dwindled to -5%, even though the S&P was still down -6%.

The VXX loses money every day in a normal market because of the way it rebalances. Each day, the VXX has to buy a certain percentage of VIX contracts, two months out, while selling that same percentage of contracts one month out. Because time is a component of option value, the longer-dated options usually cost more. This drives down the value of the fund as cheaper contracts are replaced with more expensive ones.

Buying SDS is expensive, but doesn’t require a margin account.

Inverse index ETFs such as SDS are another option – and you don’t need a margin account for this strategy. The SDS tries to mimic performance that is twice the inverse of the daily return of the S&P 500. If the S&P falls 2%, the SDS should rise 4%. We back-tested this security against the SPY and found it tracks the index closely.

The SDS is volatile, but it does what it claims to do. However, it can eat up a lot of your buying power. When you sell a stock short, you borrow the security from your broker and sell it to somebody else. Margin interest is not paid on the total value of the security. It is only paid on the dollar value the position moves against you. Imagine you sold short 100 SPY at a price of $150. If the position moves against you to $151, you would be paying margin interest on $100 instead of $15,100.

Shorting SSO provides both leverage and correlation with the S&P 500.

The SSO is the reverse of the SDS. It is a levered, long ETF that tracks the S&P 500 closely. On average, it fell 1.72 times the range of the S&P 500. If a person wanted to fully hedge a $100,000 portfolio, it could be done with $58,000 ($100,000 / 1.72 = $58,140). The investor would also only need to pay interest on the loss of the hedge, rather than the full amount.

If you have a diversified portfolio, you are naturally hedged against an upward drift in the market; shorting an index or buying an inverse ETF are ways to accomplish this goal. But remember, some methods are more volatile and require a margin account, so be sure to consider your personal situation and tolerance for risk when selecting a strategy.

Good Investing,

by David Eller,


Copyright © 1999 - 2012 by The Oxford Club, L.L.C All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Investment U, Attn: Member Services , 105 West Monument Street, Baltimore, MD 21201 Email:

Disclaimer: Investment U Disclaimer: Nothing published by Investment U should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Investment U should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Investment U Archive

© 2005-2018 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules