Hedging Update

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Hey Fellow Slopers,

In the table below, I've updated the costs (as of Thursday's close) of hedging the Dow-, NASDAQ 100-, and S&P 500-tracking ETFs against greater-than-20% declines over the next several months, using the optimal puts, along with the costs of similarly hedging a handful of their most widely-traded components. In addition, this week I added five precious metals ETFs to the table. First, a reminder about why I've used 20% as a decline threshold, and what I mean by "optimal puts".

As I mentioned last time, the threshold I usually use when I hedge is 20% (i.e., I want protection against any decline worse than that). The idea for a 20% threshold came from a comment fund manager (and Stanford finance Ph.D.) John Hussman made 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).

"Optimal puts" are the ones that will give you the level of protection you want at the lowest possible cost. With Portfolio Armor (available as a web app, and an 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 Ph.D. candidate to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

What jumped out at me in putting together this table was the cost of hedging GLD against a greater-than-20% decline over the next several months: 0.31%. With the cost of downside protection this low, if you're long GLD, you might want to consider hedging it here, even if you're bullish on it in the mid- to long-term.

Symbol

Name

Cost of Protection (as % of Position value)

Widely-Traded Stocks

INTC

Intel

3.06%**

CSCO

Cisco Systems

3.09%**

MSFT

Microsoft

2.%**

ORCL

Oracle

2.07%*

BAC

Bank of America

6.02%***

F

Ford

4.32%*

GE

GE

2.35%*

PFE

Pfizer

1.51%*

WFC

Wells Fargo

4.71%**

T

AT&T

1.55%**

AA

Alcoa

3.57% **

Major Index ETFs

QQQ

PowerShares QQQ Trust

1.48%*

SPY

SPDR S&P 500

1.04%*

DIA

SPDR Dow Jones Industrial Average

0.82%*

Precious Metals ETFs

GLD

SPDR Gold Trust

0.31%*

SLV

iShares Silver Trust

4.48%**

DBP

PowerShares DB Precious Metals

1.4%**

SGOL

ETFS Physical Swiss Gold Shares

1.09%*

SIVR

ETFS Physical Silver Shares

3.82%*

*Based on optimal puts expiring in September, 2011

**Based on optimal puts expiring in October, 2011

***Based on optimal puts expiring in November, 2011

Disclosure: I'm holding some puts on DIA.