Hedging Update — Default Watch Edition

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Credit Suisse on the consequences of a default

On Thursday, Credit Suisse's global strategy team said that a U.S. default was still unlikely. However, they predicted that if the U.S. did default, stocks would suffer a 30% drop.

Hedging against a >30% correction in stocks

With that in mind, the table below shows the costs, as of Thursday's close, of hedging 5 equity index ETFs against greater-than-30% corrections over the next six months, using optimal puts.

Hedging against a >15% correction in bonds, gold, and the dollar

The table also shows the costs of hedging gold-, U.S. dollar-, and Treasury Bond-tracking ETFs against greater-than-15% declines over the same time period using optimal puts. First, a quick reminder about what optimal puts are, and a note about costs.

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 – you can enter any percentage you like, but the larger the percentage, the greater the chance there will be optimal puts available for the position). Then the app uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones. 

A note about costs

To be conservative, Portfolio Armor calculates hedging costs using the ask price of the optimal puts. In many cases, you may be able to buy the puts for a lower cost (between the bid and the ask prices).

Hedging Costs as of Thursday's Close

Symbol

Name

Cost of Protecting against >30% Decline, as % of position

Equity Index ETFs

QQQ

PowerShares QQQ Trust

1.17%*

SPY

SPDR S&P 500

0.73%*

DIA

SPDR Dow Jones Industrial Avg

0.62%*

EFA iShares MSCI EAFE Index 1.57%*
EEM iShares MSCI Emerging Markets 1.17%*
Symbol Name Cost of Protecting against a >15% Decline, as % of position
U.S Dollar ETF
UUP PowerShares DB US Dollar Index 0.14%*
U.S. Treasury Bonds
TLT iShares Barclays 20+ Yr Treas 1.49%*

Gold

GLD

SPDR Gold Trust

0.64%*

*Based on optimal puts expiring in January, 2012