# Best derivative to hedge a long-term/buy and hold share portfolio?



## TPI (10 June 2014)

Hi there,

Just wondering what people's thoughts are on the best derivative to hedge a long-term/buy and hold portfolio of ASX200 shares? 

Say a portfolio of 10-15 direct shares.

Options, warrants, CFDs, futures... ?

I was reading about short CFDs and thinking of using these, but after reading the Commsec and IG Markets CFD PDS's this week I am not so sure.

Are there better alternatives out there?

Thanks.


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## minwa (10 June 2014)

Depends what kind of hedge you are after.

Assuming your portfolio is diversified and beta-ed to the index, then the most direct hedge is to short the futures.

If you are looking for flexibilities and not just a complete hedge then exchange traded options, assuming they are liquid enough.


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## craft (11 June 2014)

TPI said:


> Hi there,
> 
> Just wondering what people's thoughts are on the best derivative to hedge a long-term/buy and hold portfolio of ASX200 shares?
> 
> ...




Best alternative is to do nothing.

If its truly long term - the time frame will negate the randomness of the return. Everything else will act to reduce exposure and will cost you money just as an insurance premium would. If what you really want to do is time exposure to the market then buy and sell accordingly.

If you really want to hedge out risk on 10-15 direct shares as opposed to selling them, for tax reasons etc, then you should be careful to hedge them accurately (cfd's or options) as they will almost certainly move differently to any index hedge you put in place - but if an accurate hedge is not important and you can live with the granular size increments then futures are cheapest.


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## DJG (11 June 2014)

Depending on what those 10 - 15 stocks are, they could well be close enough to 100% of the index. Meaning they have such an influence on the ASX 200 that you're essentially buying the index anyway. Thinking the big miners and big banks for a start.

What do you consider long term?
Do you have a year in your head you'd like to sell?


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## TPI (11 June 2014)

minwa said:


> Depends what kind of hedge you are after.
> 
> Assuming your portfolio is diversified and beta-ed to the index, then the most direct hedge is to short the futures.
> 
> If you are looking for flexibilities and not just a complete hedge then exchange traded options, assuming they are liquid enough.




Thanks minwa,

I have 2 separate portfolios I am looking to hedge, one is more large cap tilted in my family trust (and probably moves more in line with the S&P/ASX 200 index) and the other is more mid/small cap tilted in my SMSF.

So perhaps index futures for my large cap portfolio and ETOs for my mid/small cap portfolio would be one way to go.


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## TPI (11 June 2014)

craft said:


> Best alternative is to do nothing.
> 
> If its truly long term - the time frame will negate the randomness of the return. Everything else will act to reduce exposure and will cost you money just as an insurance premium would. If what you really want to do is time exposure to the market then buy and sell accordingly.
> 
> If you really want to hedge out risk on 10-15 direct shares as opposed to selling them, for tax reasons etc, then you should be careful to hedge them accurately (cfd's or options) as they will almost certainly move differently to any index hedge you put in place - but if an accurate hedge is not important and you can live with the granular size increments then futures are cheapest.




Thanks craft,

Good points, I am looking to hedge rather than time and buy/sell.

I'm thinking that for my large cap portfolio an accurate hedge might not be that important so index futures sounds like they could be a better option here, especially if they are cheaper.

Will add index futures to my reading list!

I'll have to read a bit more about put options (and their costs) compared to short CFDs to see which of these is better for my mid/small cap portfolio.

As I understand it now options will have an expiry period (where CFDs don't) and no margin calls/variations (as CFDs do), but if the option premium is sufficiently low and a reasonable expiry period is available (ie. not too short) they maybe a better alternative.


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## TPI (11 June 2014)

DJG said:


> Depending on what those 10 - 15 stocks are, they could well be close enough to 100% of the index. Meaning they have such an influence on the ASX 200 that you're essentially buying the index anyway. Thinking the big miners and big banks for a start.
> 
> What do you consider long term?
> Do you have a year in your head you'd like to sell?




Thanks DJG, 

You're right, my family trust large cap portfolio does probably mirror the ASX 200 to some extent.

Long-term is 40-50+ years I guess for me, subject to my life expectancy! 

Another boring dividend collector here, so no plans to sell unless there is a fundamental change to the underlying business and its prospects.


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## ROE (12 June 2014)

Long term you need not do anything if you hold decent business 
(strong cash flow, reliable revenue stream, low debt etc..)

yes there maybe a market correction every so often or crash but strong business
will come back and rather than worry about a temporary price decline 
buy some more when that times comes.

dont worry about commentators who said buy and hold doesn't work, or it is a different time
and you got to constantly worry about your stock or hedge it or whatever, their jobs is to create
noises and generate activities.

things has not change in hundred of years, if the business deliver increase earning and dividend with time
then you don't need to worry about the stock price.

in fact volatility can be a good thing for you to aim and get into solid stocks and hold long term.

Best hedge for me is holding decent stock, write covered call when it run a bit hot and get some
income


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## TPI (12 June 2014)

ROE said:


> Long term you need not do anything if you hold decent business
> (strong cash flow, reliable revenue stream, low debt etc..)
> 
> yes there maybe a market correction every so often or crash but strong business
> ...




Thanks ROE, 

What you say makes sense.

Thinking about this further, if I were to hedge at a certain point in time mainly in case of an anticipated large market crash (like the GFC), whether I use futures, CFDs or options, and whether it is over individual stocks or an index, my ability/skill in timing the peak of the broad market with any precision is not great or reliable anyway.

If my precise timing is wrong it will cost me in increased margin/variation margin payments, being stopped out of positions and having to re-enter, or more option premiums as options expire and having to re-enter (and with options I think they don't go up/down in 1:1 ratio like CFDs/futures do so you may need to sell to really take advantage of this anyway... but I could be wrong on this).

And if we are at this pointy end of the market cycle then volatility may be higher, which may result in quoted margin requirements increasing, borrowing costs increasing, guaranteed stop-loss costs increasing and option premiums increasing, thus decreasing the cost-effectiveness of hedging at this point in time with these derivatives when you need them most.

So it perhaps makes more sense to use derivatives like short CFDs on individual stocks that you know well and where you have a high conviction about the direction of share price movements and the timing of this.

And derivatives like covered calls, like you mention, and perhaps cash covered short puts as well to generate extra income as another form of hedging.


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## TPI (13 June 2014)

TPI said:


> ...or more option premiums as options expire and having to re-enter (and with options I think they don't go up/down in 1:1 ratio like CFDs/futures do so you may need to sell to really take advantage of this anyway... but I could be wrong on this).




Reading a bit more about this, it does look like option prices vary depending on a number of factors.

But even if there isn't a 1:1 relationship to the share price, if share prices fall there will be some degree of gain on the option price to offset this loss at least partially by selling the option itself (without having to exercise the option and sell the underlying shares).

So using put options (either for individual stocks or just over the XJO for simplicity/cost-efficiency) in this way as a partial hedge maybe a lower risk way of hedging a portfolio rather than using short CFDs/short futures where you incur margins/variation margins (particularly if your timing is wrong).

If you buy a put option that is slightly out of the money and with a longer dated expiry period the premium for this maybe cheaper.


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