# How to hedge a long position?



## Lone Wolf (18 January 2009)

G'day

I'm new to the markets, previously I went to a financial advisor and entered into a 'buy and hold' investment in an ASX200 index fund. I'd like to limit any further losses should the market head further down.

Easy solution is sell up and wait for a recovery. But there would be fees involved in re-entering the fund. Plus I'd struggle with when to re-enter the market, wait too long and you miss the boat, get in too early and you're back where you started. So with that in mind I'm looking to hedge my long position.

What is the best way to hedge an investment and why? Would you use futures, CFD's or options? I haven't ever looked at options, I understand the basic concept but don't know enough to trade them. Futures seem better than CFD's due to CFD's being a market maker product. 

Are there any traps that a newbie could fall into trying to hedge a position? For example, if I were to use CFD's, by going short I'd get hit with a fee for any dividend payments while I'm short. But then again my long position should also gain the same amount from any dividend payments.

Do you just go short with no stop loss and wait until the market stabilizes? Or is there a smart way of hedging a long term investment? Do you treat each day as a new trade, setting a new entry point and stop loss?

If you go short with no stop then for every day that the market goes up you lose gains. But if a newbie like me tries to be smart and only short the down days I might just lose even more money. For example, I go short with a 40 point stop, the market may move down enough to trigger my short entry, then move straight up to trigger my stop, then turn around and finish the day low. So even though I went short and the market finished down for the day, all I did was lose 40 points (plus the big spread if CFD) by being stopped out. 

Note that I am not looking for specific advice and quite frankly, blindly following other people's advice is what got me into this mess in the first place. But (I feel) I'm running short on time before the next market fall, so any opinions or 'food for thought' to help speed my education would be greatly appreciated.


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## cutz (18 January 2009)

G’Day,

One obvious method to hedge an ASX200 index fund would be to purchase ASX200 index puts (XJO), out of the money. An experienced player may also sell and actively manage out of the money calls but in my own opinion it’s probably too late to enter into a hedging strategy as the damage has already been done.

Another thing to consider is hedging now could end up costing more in the form of expensive premium or capped out gains for when the market eventually recovers.


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## drsmith (18 January 2009)

Lone Wolf said:


> Easy solution is sell up and wait for a recovery. But there would be fees involved in re-entering the fund.



That could turn into sell up and miss out on the recovery.

As for hedging strategies there is a cost which over the long term will eat somewhat into your investment returns.

As for fees it's a simple index fund so the fees should not be too great. As a guide ANZ has an online investment account which tracks the ASX200 index. There's a 0.25% transaction fee and a 1%p.a. management fee.

It's a natural response to be fearful of shares after the falls we have seen but looking at it another way would you rather buy shares now or when they were 40% higher.

No one knows what the share market will do tomorrow and these are interesting times. The safest strategy for  shares is to invest small amounts frequently.


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## cutz (18 January 2009)

drsmith said:


> As for fees it's a simple index fund so the fees should not be too great. As a guide ANZ has an online investment account which tracks the ASX200 index. There's a 0.25% transaction fee and a 1%p.a. management fee.




Guys check out this fund, ASX200 SPDR (STW), traded via the ASX, 0.286%MCR, pointed out to me by one the guys on this forum. http://www.spdr.com.au/etf/fund/fund_detail_STW.html

Beats those stupid funds that are recommended by the banks.


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## Lone Wolf (18 January 2009)

Thanks for the input.

I thought that options may be a preferred way for many. But I want to avoid them at this stage because I feel I need to know much more before getting into them. Besides, as you say cutz, the premium may be too expensive for my tastes.

Drsmith, something I didn't mention in my original post is that much of the long investment is borrowed money. So yes, choosing to sell now is a bad idea, but if the market falls too far the bank will force me into selling and I'll be left with nothing. If I can ride out these troubled times without selling up I'll be fine, but to do that I may need to reduce my risk by hedging.


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## Lone Wolf (18 January 2009)

Ah Cutz, I'm so glad you brought that up. 

I was looking into ETF's myself as I want a more cost effective way to gain exposure to the ASX200. A couple of things concerned me about it. The first is that the volume seems quite low. The second is that the product disclosure statement lists one of the risks as - the STW may be delisted from the ASX. Because you don't own any shares in the underlying companies, if the STW is removed from the market you'll lose all your money won't you?

You seem to like the ETF, what's your take on the low volume and risk of delisting issues? I want to like ETF's, they seem like such a great idea.


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## drsmith (18 January 2009)

Accounts like the ANZ one are best suited to investors who wish to gain exposure to the share market through a saving plan with small regular deposits. 

There is of course a point where purchasing shares in the listed ASX200 fund through a stockbroker results in less fees overall relative to the size of the investment.

I provided the ANZ example as a reference for something as simple as opening a bank account. I just hope Lone Wolf's fund didn't charge him something like 5% of his capital as an initial investment fee like they used to in the bad old days.



Lone Wolf said:


> Drsmith, something I didn't mention in my original post is that much of the long investment is borrowed money. So yes, choosing to sell now is a bad idea, but if the market falls too far the bank will force me into selling and I'll be left with nothing. If I can ride out these troubled times without selling up I'll be fine, but to do that I may need to reduce my risk by hedging.



Have you borrowed via a margin lending facility ?

It sounds like you have.


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## MRC & Co (18 January 2009)

Depending on how much you have invested, you can sell a SPI futures contract or more to cover a portion.

Just 3600 (or whatever value the SPI is trading at at the time) *25 will equal the value of 'stock' you have sold (hedged).

But even with hedging, you still have to time the market.  When do you cover the hedge (buy back the SPI contract)?  It's going to have the same ramificaitons as selling or buying back your actual physical stock.  Only difference will be it may be a cheaper option as far as transaction costs, as you say.

Personally, if I was you, I would just de-leverage, sell whatever portion of your shares which were brought with borrowed money.  It's not the time to leverage at the moment, unless you are a skilled trader and leveraging short timeframes with a known risk (stop loss).  

All the best with your decisions, sorry to hear about your predicament.


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## jackson8 (18 January 2009)

hi lone wolf

just to give you an idea of cost of hedging using xjo puts 

with a portfolio of $35 k it would cost approx $3600 for just over 5 months of cover

also depends which stocks you hold and how closely they follow the index

this is a rough guide only and others may have better mathematical skills than myself who may like to comment

Gary


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## long88 (18 January 2009)

be careful on who you take advice from. (like what you said that you get into this mess here, any advice here could get you into further losses).

if i were you. i would educate myself, be it options, cfd, futures. after you know the game, i think you wouldnt have to ask this questions anymore.

This is your money, and you are the one who knows your own circumstances, so why not ask yourself.

Cheers



Lone Wolf said:


> G'day
> 
> I'm new to the markets, previously I went to a financial advisor and entered into a 'buy and hold' investment in an ASX200 index fund. I'd like to limit any further losses should the market head further down.
> 
> ...


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## cutz (18 January 2009)

Hi Lone Wolf,

Yeah I looked into STW, the volumes seemed OK but there are no volumes on STW options which put me off as I prefer stocks with option activity so saying that I’m actually exposed to the S&P 500 SPDR trading in the US via options and not the ASX200 version.

The point you made about delisting risk I can’t see it being a problem as the EFT mimics the ASX200 by actually owning the stocks that make up the ASX200. So the impression I get is if STW delists there has to be a transfer of the underlying assets or cash back to the fund holder, please do your own research here as I’m not 100% on this aspect.

So to answer your questions, personally the issue about delisting would not be a concern of mine, volume is not as great as a big stock like BHP but its there.

This is my opinion only so please check it out further for yourself before jumping in.

Hope this helps.


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## cutz (18 January 2009)

long88 said:


> be careful on who you take advice from. (like what you said that you get into this mess here, any advice here could get you into further losses).
> 
> if i were you. i would educate myself, be it options, cfd, futures. after you know the game, i think you wouldnt have to ask this questions anymore.
> 
> ...




Isn’t that why Lone Wolf is here, he is asking the questions and getting independent advice from a good cross section of the investment community, it’s good and well to say that you need to read books, educate yourself get to know the game bla bla bla but I’ve read a lot of books on options and investing but it’s not until I have stumbled across gems written in these pages that really make some things come together. If something bogs you down ask it here and it will be answered.

There are real traders here that know a ****load more than the professionals that people pay money to hear speak or obtain advice.


BTW, i'm not one of those.


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## MRC & Co (18 January 2009)

cutz said:


> There are real traders here that know a ****load more than the professionals that people pay money to hear speak or obtain advice. .




Yes, some of the guys (and girls) here know a stack more than 'professionals' you will pay to hear speak, and best of all, it's free!  

Other thing is bad advice, will generally be ripped apart by those with knowledge in the area, which is why I like it most.  It's easy to decipher the good stuff from a lot of the junk some people write.


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## Lone Wolf (18 January 2009)

I saw the ANZ thing just before Christmas. Looks pretty good for the average Joe putting some money aside for shares on a regular basis. Had it been around three years ago I may have gone that way instead.

Yes I did borrow from a margin lending facility, transaction fees were lumped with the advisor fees at the time of my first investment three years ago, so I can't remember how much went to who, but the total was more like 10% with ongoing management fee.

MRC & Co, thanks for the info. I think I'd have an easier time deciding when to enter and exit with the SPI than with a managed fund. If the market seems to change direction again I can enter or exit the market with a click of a button. With a managed fund I'd sit tight because I'd be worried that if I change my mind I have to call them, write a letter and sign it and blah blah... And thank you for your well wishes. But really, if I'm in a predicament it's because I put myself here. I could say that I trusted my advisor and that got me here, but it's my money, my decisions.

Jackson8, thanks for the approx cost, even if it were half that cost I think it'd turn me off. I'd be paying too much to protect myself from something that may never happen.

Long88, you are correct in what you say. I've had many questions before this one but I've never posted because I always end up finding my own answer before I do. But I find that many times a little discussion gives me some great ideas. Just the act of sitting down to think about what exactly it is you want to ask can lead to new ideas. Rest assured, I now do nothing unless I've done my own research.

Cutz, that makes sense about the STW delisting issue, I'll check it out.


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## cutz (18 January 2009)

Good luck Lone Wolf with whatever you decide,

Hopefully Market 2009 is a lot more settled than last year.

Catch you later.


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## MRC & Co (18 January 2009)

Just be careful on the futs that you have to role the contract each quarter.

Swapping your funds from the current managed fund, to an ETF, would mean you would no longer be paying the management fees and would be better off.  Not too late to change it.


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## jackson8 (18 January 2009)

hi lone wolf

just a couple of links if you would like to read up on the subject

http://www.theoptionsguide.com/portfolio-insurance-using-index-puts.aspx


http://www.theoptionsguide.com/portfolio-hedging-using-index-options.aspx


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## wayneL (19 January 2009)

Hedging is always a very difficult thing.

Set and forget hedging is even more problematic, especially hedging one instrument for another. Then there is the issue of margin/premium; this requires additional capital to put on the hedge.

Options are too expensive right now for an outright put purchase... theta will eventually rip the investors balls out. Sure you can go further out of the money and the put will be cheaper, but then your risk is substantially higher.

Put buys are more effective at highs, when they are cheap.

Futures and or CFDs can be a more perfect hedge, but there are problems here too.

1/ Matching the face value of the derivative. Futures are in approximately $90,000 chunks. Unless the amount in the fund matches the mentioned denominator, the hedge will be imperfect. CFDs are more flexible with regards to position size, but there is counterparty risk.

2/ Does the fund accurately track the S&P 200? 

3/ Either situation will require margin, which can substantially increase with market movements.

4/ 100% Hedging with these instruments will also completely remove upside potential as well.

You can however "partially" hedge.

If it were me, I would hedge dynamically with option spreads... but I know the odd thing about options. This would probably not be an answer unless you knew a bit about them though.

Just a couple of things to think about... sorry no real concrete answers though.


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## Trembling Hand (19 January 2009)

wayneL said:


> Hedging is always a very difficult thing.






Lone Wolf said:


> Yes I did borrow from a margin lending facility, transaction fees were lumped with the advisor fees at the time of my first investment three years ago, so I can't remember how much went to who, but the total was more like 10% with ongoing management fee.
> 
> MRC & Co, thanks for the info. I think I'd have an easier time deciding when to enter and exit with the SPI than with a managed fund. If the market seems to change direction again I can enter or exit the market with a click of a button.
> 
> Jackson8, thanks for the approx cost, even if it were half that cost I think it'd turn me off. I'd be paying too much to protect myself from something that may never happen.






jackson8 said:


> with a portfolio of $35 k it would cost approx $3600 for just over 5 months of cover






Lone Wolf said:


> I'm new to the markets,




Ok so some have kindly suddgested how hard this is but I will not be so kind 

FORGET ABOUT.

As you have said you are *new* to the markets, As Jackson has pointed out hedges are VERY *expensive* and as wayne has stated hedging is *hard* to get right.

My view on this topic is hedging is either for very experienced players or marketing scam for rouge snake oil salesman. What would make you think you could time the SPI hedges (or other) any better than your last trade? You will just end up having two bad trades that will tie you up in knots. If we run higher you will miss it because you are hedged. If we fall you will most likely be down anyway because of costs and if we go nowhere you will be down (cost) & confused whether or not to close out the hedge.

Deal with your 1 position by reducing it to a level that you can sleep at night even if we do fall from here. The problem with leverage is it will push you into a state of denial. You need to take care of business and accept the loss and take real steps to reduce further impact. I would say unfortunately that means not hedging but closing out a good part of it.

IMHO


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## drsmith (19 January 2009)

Lone Wolf said:


> I saw the ANZ thing just before Christmas. Looks pretty good for the average Joe putting some money aside for shares on a regular basis. Had it been around three years ago I may have gone that way instead.
> 
> Yes I did borrow from a margin lending facility, transaction fees were lumped with the advisor fees at the time of my first investment three years ago, so I can't remember how much went to who, but the total was more like 10% with ongoing management fee.



10% in fees is a lot over 3 years. The ANZ product by comparison would be 3.25% over the same period and the ASX200 SPDR (STW) fund less again for the amount you would have invested.

There are no easy answers when one's debt level is such that it dictates one's actions. Debt is a good slave but it is a poor master. As others have suggested the most prudent course of action is to reduce the debt to a more managable level. In the absence of alternative cash resources such as money in a bank account or term deposit this means selling some of your holdings.

With your margin loan are dividends and/or cash from other sources being used to pay the interest or is the interest being capitalised onto the overall debt ?

With regard to fees if negotiation with the financial advisor who is responsible for your investment structure fails to result in a reduced fee structure you can always sell the lot, pay out the margin loan and reinvest your remaining equity in the ASX200 through either of the alternative products above.


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## Lone Wolf (19 January 2009)

Thank you very much to everyone who took the time to reply. I gained a lot, I learned something about options, alternative investment funds, hedging, and last but not least, had my hopes and dreams crushed under the weight of reality.

The risks outweigh the possible benefits. I'd have to take the remaining cash kept aside for margin call of the long investment and use it to supply the margin for the hedge. As long as I'm 100% hedged I'll never get out of the hole because I can't profit from a market recovery. If the market goes up I'd have to sell shares in the long investment to cover the margin of the hedge which is now losing money.

A partial hedge may be better. But it still contains the same flaw, an inexperienced trader at the wheel. I guess it's just that if I can hang on till the market recovers I won't have wasted the last 10 years of my life saving every cent I could. So I was hoping to make the best of a bad situation by at least making some money from the market fall. But all I'd really be is an inexperienced trader loaded with debt, gambling the last of his money to win back his loss. I know that if someone came to me with the idea I just posted here I'd tell them "Sounds like you're digging yourself a deeper hole". I already knew this, but I didn't want to miss an opportunity if there was one there.

Oh well, I'll look at moving what I have left to a fund with less fees, learn as much as I can about the markets and make it all back some day. Then someday it'll be my turn to nicely tell some young trader that he's stuffed.  

Cheers.


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## drsmith (19 January 2009)

Your not stuffed, just stiff to have invested aggressively just before Mr Market's mood became the most sour in a generation.

The key now is to restructure to a debt level you are comfortable with and look forward from there.


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## MRC & Co (19 January 2009)

Excellent self critical analysis Lone Wolf IMO.


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