MorningWord 12/9/14: What’s In Your Portfolio?

by Dan December 9, 2014 9:32 am • Commentary

From time to time we detail portfolio hedges when we think equity markets are extended, complacency is high, sentiment is exuberant and options premium is cheap. We have not done one for a bit as we think for the most part is likely to be an okay final month the year. This is despite growing turbulence overseas, both from an economic & geopolitical standpoint, not to mention the crash in oil and ever present dollar strength. Things could get real, but I suspect not in 2014.

I do think it is important to remember that yesterday’s close in the S&P500 was just 1% from the all time high made on Friday. And from some of the communication that I am getting from readers of RiskReversal or viewers from CNBC anecdotally, people seems to be increasingly worried about protecting equity gains in their portfolios. While options are often considered to be a sort of saftey blanket for investors looking to slap on some quick protection, I think it is important to first focus on what you own and do some research about appropriate hedging strategies for your portfolio.

I want to share with you the response to a reader question from yesterday:

Hi Dan,
Market is weird and portfolio profits keep eroding every day, for the last few weeks.
Is it time to hedge the portfolio. Any ideas?

And here was my answer:

I am not a registered investment advisor, so I can not make recommendations. But I will say that it could be a very good time to re-evaluate what you own, why you own what you do, consider how diversified you are among stocks, sectors, asset classes and what sort of correlation they have to each other. Also its important to place limits on risk assets that you own, have an idea where you would reduce the position size, where you would close altogether, and where you take profits.

These are the first steps of portfolio risk management. At some point, with profits eroding you need to reduce risk unless you are confident the stuff you own is going to bounce back. Which leaves you to reduce exposure or lessen exposure through hedging. As for portfolio hedges there no shortage of ways to do this with options, long puts, long put spreads, short call/ long put or put spread…..etc etc.  But you will have to get a sense for the notional value you want to protect, choose the proper underlying to hedge that has appropriate correlations, and there are many other factors. I hope this at least starts to stimulate some thought, and if it is important enough you should seek out a financial advisor who can help you implement such a strategy.


There are some great ways to hedge a portfolio using options and as I said in the email it all just depends on how much of the portfolio you want to protect and then finding the right structure. As I mentioned last week, we’ll be looking at some portfolio hedges targeting the New Year soon and will feature them on the site, but first things first get a sense for what is in your portfolio, as there are no magic bullets. Stay tuned.