#355 - Does Hedging A Portfolio Help Or Hurt?

Episode of: The "Daily Call" From Option Alpha

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Sep 12, 20183m
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#355 - Does Hedging A Portfolio Help Or Hurt?
Sep 12 '183m
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Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to answer the question, “Does hedging a portfolio help or hurt?” Well, the answer to this question is it depends. It depends on what happens during the timeframe that you have the hedge in place for your portfolio. Now, of course, the idea of hedging a portfolio is the concept that we’re going to take a little bit of the portfolio’s account or income and purchase some sort of insurance or protection either in full or partial on the rest of the portfolio. The idea is that this hedge kicks into place when something bad happens. For example, in the insurance and housing business, this would be the homeowners insurance that you have on your house, so that if God forbid, the house were to burn down to the ground, the insurance would kick in and help repay to rebuild the house or relocate you and your family. It’s the same concept with options trading and with a stock portfolio. What most people do is they do buy portfolio insurance and protection. At least most mutual funds and fund managers do this on a reoccurring basis. Whether they use individual option contracts or general broad markets contracts like VIX, VXX, UVXY to hedge, they will generally have a small hedge in place.

Now, the answer again is it depends because if the market does go down and those hedge contracts increase in value, that can help kind of shelter the portfolio to some degree from a large move down or up in the markets. If the markets do not make the large move that's required for the hedge to kick in and start generating income, then obviously it hurts the portfolio. Now, as a general rule, we prefer to be on the opposite side of a hedge trade, meaning that we prefer to be the insurance company in this analogy and to sell insurance to people, sell options contracts to other people that are looking to hedge. This means that we generate in our opinion and based on our research and lots of data, we generate higher expected returns with much more consistent income stream by being an option seller. We believe that more often than not, insurance as a purchased portfolio protection vehicle does not generate a proper hedge for a portfolio and therefore, the money that's really made in many of these instances is made by the insurance companies collecting premium and letting the markets be very calm over the course of a couple of months. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.

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