There have been a couple of comments making reference to the use of double short funds to hedge. I do this for most accounts.
One thing about the use of these funds to keep in mind is that as the market goes down the size of the the double short you own gets larger relative to the rest of the portfolio meaning it hedges more and more as the market goes down.
If you take no action into a decline, and this post is not about whether you should or shouldn't, you will become more hedged.
To use a simplified example. An account has $90,000 in SPY and $10,000 in the double short S&P 500 fund (which I own for clients). The market then drops 10%. The SPY is now worth $81,000 and the double short is now worth $12,000.
$12,000 is obviously a much larger percentage of the total account of $93,000 (after the drop) than the $10,000 was of the total $100,000 before the drop.
Keep in mind that this example is very simplified and that there is no guarantee as to what a double short fund will do.
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19 comments:
These double short funds can't perform exactly as stated.
1) If the index goes up more than 50% the double short is not going to go below zero.
2) Watching the values today, the double shorts seem to perform less than -2x, maybe more realistically at -1.5x.
3) An index cannot fall below zero so the double short should not be able to go higher than twice the current value of the index but once the index goes up, that number is larger and the double short should be able to go above this value. This means there is no "lock" between the two.
I'd love to hear the explanation of the math behind these. Thanks.
The first thing to understand is that the intention is that they capture twice the inverse on a daily basis which I think offsets most of your questions.
Most of the time they do work but you are correct that it will not be perfect.
If you look at a chart you will see periods where it does capture twice the inverse but also time where it does not.
You need to weigh for yourself whether this is appropriate or not. I can say that on really bad days it does help.
I don't really understand the point of owning a hedge like this. They lose as the market goes up so you limit your returns. You do this in exchange for a less volatile portfolio. So my question is, why not just generate a less volatile portfolio?
I'm not saying that one should never play the market to the downside, but to have something like this in place 24/7 seems beneficial to no one but your broker.
Would appreciate someone setting me straight on this.
billb the case for this is easy, you either find it appealing or you don't.
A diversified portfolio can be thought of as a mix of stocks that are all either up or down by some amount and the blend gives you your result.
If everything you own goes up together what will they do when the market goes down? I prefer to have a couple of things that I "know" will go up if the market is down. Most of the time this works but not always.
"Why not build a portfolio that is less volatile?" That is exactly what owning one of these does but they are not for everyone.
I think I read a sentiment in your question that is very common so I will ask a question for anyone to answer for themselves.
What is more important, the portfolio result or how each of the holdings do when looked at independently?
I tend to believe the portfolio result is by far the more important thing. If all the gold miners are down 20%, including the one you own and at the same time the rest of the portfolio is keeping reasonably close, either way, with an up market are you really upset about the one stock?
Being upset, worried or whatever in that scenario is focusing on the wrong thing, IMO.
If the mining stock in question were down 20% and the rest were flat, well that could be reason to re-visit whether it should be held.
As I read the question, and sorry if I have misread, this is a forest for the trees thing.
Roger, I appreciate the time and comments. I really didn't mean to imply anything outside of the question/statement. Your comment .. "If everything you own goes up together what will they do when the market goes down?" seems to outline a most ideal and unlikely situation. If everything I owned went up, what a wonderful time that would be. :) But my nervous response in the short term might be to move to something less volatile like cash and save up for the next rainy day. So maybe this becomes a question of style.
In either case, if we're "wrong" and things continue to go up, we're missing out on a better return. I've been less and less of a market timer and hedger on my long term holdings because I find that I'm generally wrong at picking tops.
To answer your general question, I'm more concerned with the return of the entire portfolio rather than anything individually. I'm often wrong on individual picks, but need to be right more often than not. If that turns out to not be the case at some point, than I re-analyze the entire approach to constructing the portfolio.
Of course, I will always try and tweak, learn more, understand the inner workings and that results in looking at individual issues, but all in all, it's the bottom line.
I'm still new at this. I've always been a swing trader, but need to start becoming more "responsible" as the nest egg grows :)
i too do not agree with the usage of the double inverse funds. In your example, the 10k of double inverse cancels out the $20k of the SPY leaving $70k un-affected. May as well put $70k in the SPY and $30k in a CD. would outperform the hedge on the downside and on the upside.
In my opinion a better usage would be to use your top down approach to find a weak sector and hedge using that.
For example, if you believe that REITs are going to underperform the SPY for the next 12 months then put $90k in the SPY and $10k in double inverse REIT ETF.
Sami, I should have been clearer when I said simplistic example. Owning 90% SPY and 10% in a fund that goes inverse SPY clearly makes no sense. I was trying to conserve space and make the example as simple as possible.
For anyone trying to weigh this out for themselves, substitute the long 90% of SPY for your portfolio and WRT to an inverse fund, I have no where near 10% invested.
This was JUST AN EXAMPLE to illustrate how it works.
Roger,
Quick Question: Do you see this as a correction or a start of a bear/down market??
Oh my, this post is the work of a rank amateur.
As others have pointed out, your "hedge" merely cancels out 20 percent of the long position, with a substantial expense of owning two funds that cancel each other.
Roger, have you ever heard of modern portfolio theory? Owning two positions that are perfectly inversely correlated is pointless.
1. Investing is an art, not a science.
2. Some luck is involved in successful investing.
3. Diversification means investing in more than stocks and bonds.
4. Don't be too smart by half.
5. Take a break and appreciate what you have, in spite of some temporary loss.
6. Long term, diversified investments work out very well.
7. Don't let the mainstream media dictate your emotions.
Enjoy your weekend and if you must tinker with a few portfolio components, do so only for a compelling long term reason.
Anon 4:44.
This guy thinks that we are heading towards a bear market: (click on 'Weekly Market Monitor')
http://www.pbs.org/nbr/info/video.html
This guy at http://jasmts.com/ has been calling for a bear market for a while now and has a model that supposedly never fails at predicting a bear market when his model reaches what he calls 'critical mass'. He says that the model is near that now.
I personally don't see owning stocks now through at least September, which is historically one of the worst months for stocks. I will stay in cash and buy some short issues like SDS, QID & TWM. Or you can buy UCPIX. I will then re-evaluate the market through October and buy on dips.
The sky is falling! The sky is falling!
There have been 8 Hindenburg omens. October is the last date for predicted crash.
Equates to cognitive dissonance.
This is the first down leg of a 5 wave cycle. Sell short on 3. Big time!
Exit when the pain is unbearable doesn't seem a plausable strategy to me.
This isn't a correction but a paradigm shift that will last a decade.
very important people in the know are seriously reducing their risk exposure this summer for a reason
our administration's talking heads have been hinting at another terror attack happening this summer
crude oil has built up a major risk premium
if you watch Loose Change 2nd edition Recut on video.google.com you will see that a military operation simulating a plane hitting a building happened that same fateful morning on 9/11/01
on August 2nd, Operation: Noble Resolve will be simulating a ten mega ton nuke in Portland, Oregon
we might be getting our second false flag operation soon
i pray i am very wrong
see the video and make your own opinion about what really happened in NYC and the pentagon
peace
I am going to put duct tape over my windows. This is bad, real bad.
Roger,
Anybody paying you for portfolio advice is a good candidate for purchasing my Miami condo. Please forward the names of these morons to me.
Thanks.
Thanks for the great video today, Roger. There are always knucklehead posters who will either succumb to ad hominem attacks, or political blather. If folks don't appreciate your advice, let them start their own blog.
As far as "smart money", you have the timers like Brinker, the pumpers like Cramer, the gloomers like Gross, the buy and holders, and the diversified (including shorts) portfolio guy, like yourself who apparently have exit strategies. The smartest guys are always defined that way ex post facto.
Just three questions for Roger or anyone....do you pull everything out at the 200DMA? At what point do you buy inverse funds (if you do)?, and who are the guys you trust the most for market advice? Thanks, and keep up the good work. Scoot
I do not pull everything out ever, that is a huge bet likely to result in getting whipsawed. I would tell you to search "exit strategy" in the search box for other posts on this.
The very short is if we close below the 200 DMA I would start with baby steps to reduce net long exposure, and keep on for a while if things don;t improve. when it goes back above the 200 DMA I would start getting longer again.
I have had a small position in SDS for a year along w/a fair bit of cash. Thanks to some lucky sector and stock picks it has worked out in client accounts.
In response to other folks comments that you should not bother with SDS and the like, rather going with a risk free investment, instead of the combo - this is an overstatement. If you feel the stocks you are buying on the long side are likely to outperform the index, then the short position makes the combo more like an alpha-producing market neutral fund.
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