Hedging A Stock Portfolio by Tom Basso

[ScottMcNab]

Was listening to a podcast talking about a way to (contribute to) downside risk in long equity portfolio using tranches

eg For our monthly rotation systems, they would divide equity it into (eg 4) parts and trade 4 different systems…still monthly signals but each one trades on a different week ..eg Monday of week 1,2,3 and 4..idea being that if large drop occurs removing impact of bad luck occuring if downturn begins the day after performed rotation

[SaidBitar]

Len Zir wrote:

I researched Spitznagle’s strategy for hedging tail risk. Assuming a portfolio of 95-97% SPY at the end of each month you buy 0.5% of the portfolio value in 2 month OTM puts whose price is 30% below the SPY. At the end of each month you sell the puts and buy new 2 month puts. The breakeven occurs when the SPY goes down 20% If the spy goes down 20% this portfolio goes down 26%.If the SPY goes down 30% the portfolio loses 12.95% If the SPY goes down 40% the portfolio goes up 181%. I obtained these numbers from zerohedge.com.
No wonder Spitznagle has a multibillion dollar hedge fund since his portfolio skyrocketed in 2008.

This sounds interesting but i imagine backtesting it is tough.

just simple question (not tested yet) but it is similar to the one that Tom Basso mentioned everyday you calculate the lower band value and you place orders to short SPY and will cover at close
the amount to short is maybe 25% of the account size and you define another level (lower than the first one) if the SPY will hit you cancel the remaining entries and short another 25% SPY

sounds like a recipe for disaster but i will test it when i have time

[Nick Radge]

I agree it would be very difficult to test, however, I think it important to remember what its used for.

It’s not designed to alleviate every downside blip the market has.

It’s designed to save you from a catastrophic event such as 1987.

One could argue that it only be used during extreme or parabolic times such as we’ve had.

[ScottMcNab]

Scott McNab wrote:

Was listening to a podcast talking about a way to (contribute to) downside risk in long equity portfolio using tranches

eg For our monthly rotation systems, they would divide equity it into (eg 4) parts and trade 4 different systems…still monthly signals but each one trades on a different week ..eg Monday of week 1,2,3 and 4..idea being that if large drop occurs removing impact of bad luck occuring if downturn begins the day after performed rotation

Not the application intended in their discussion but I wonder if such an approach could be applied 2 other ways

backtesting…more confidence in a monthly system by generating 4x number of signals (although not really independent)

liquidity…in market where liquidity filters killing the results it may be possible to break equity into 4 equal portions and trade on the first day of the month as well as days 6,11,16

[LEONARDZIR]

Scott,
Interesting idea. I did test mid month rotation in sp500 and it had essentially the same outcomes as end of month.
Another thought. Just finished reading “Market timing with moving averages “ by Zakamulin. An arduous but informative read. In essence the best monthly filter in his database was simply moving average crossover of 2 month and 10 month moving average. The filter we use namely a close of the $spx below it’s 10 month was also excellent.
If using daily data a close below an sma with an envelope was the best trading strategy.(close< 230sma with 2.5% envelope was best).
So it might be worth testing the same system with 2 filters,one with monthly data and one with daily data.. I would assume using daily data you continue to do a monthly rotation but if at any time during the OnTheSnow the daily filter triggers you move the portfolio to cash.

[LEONARDZIR]

On the snow weird . OnTheSnow should be month.

[ScottMcNab]

Thanks Len. I will test those filters. I was thinking of still only doing the rotation once a month…so would only exit on that one day if index filter turned the system off. I tested on days 5,10 and 15 (taken from the first day of the new month). There seemed to be a definite “end of month” effect in that the systems on the first day of the month had a cagr a few % higher

[RobGiles]

Just out of interest Nick, did you place a hedge on any of your portfolios?

[Nick Radge]

For the DTVI yes. But my calibration was slightly out so am under hedged.

Had it been correct, instead of a -17% loss this month, it would be -6%.

Live and learn…

[RobGiles]

Interesting. So you will take the hedge off as per Tom Basso’s rules?

[Nick Radge]

I’m not using his rules.

[LEONARDZIR]

Nick
Could you tell us more about you are using a hedge? Perhaps a section in the mentoring course?

[LEONARDZIR]

Scott,
FYI, the SPY closed below the 230ma with a 2.5%band (mentioned in my earlier pos) this past wednesday. Interesting to see the difference between that close and the close at month’s end especially with the US market in panic mode.

[JulianCohen]

Len Zir wrote:

Nick
Could you tell us more about you are using a hedge? Perhaps a section in the mentoring course?

Or a video like you did on the FX exposure hedging of an AUD portfolio maybe?

[JulianCohen]

Couple of things I have thought of Nick and I’d appreciate your thoughts.

1. The S&P Dec futures run at a 0.9 Beta (20 day average) so should we consider that in the calculations?

2. As the hedge will trigger at the Keltner Band, I think the calculation for the hedge should be based off that entry price and not the close of the S&P?

Probably small issues I’m sure but I was interested in the process….

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