Updates: Portfolio Hedges $IWM, $QQQ, $SPY

by CC January 15, 2016 2:10 pm • Trade Updates

We had a hunch 2016 could get off to a rocky start. With the way stocks creeped higher into year end 2015, shaking off headwinds left and right, we thought it wise to detail some tactical portfolio hedges on December 29th. At the time stocks had rallied from early December lows and implied vol had collapsed during the holiday shortened trading weeks. That’s what we wanted to see for an entry.

Let’s first recap the trades from December 29th and original rationale and then we’ll go over how we should manage these:

Trade – IWM ($114.80) Buy the Feb 110/100 put spread for $1.15
  • Buy 1 Feb 110 put for 1.55
  • Sell 1 Feb 100 put at .40
Trade – QQQ ($114.20) Buy the Feb 110/100 put spread for $1.15
  • Buy 1 Feb 110 put for 1.55
  • Sell 1 Feb 100 put at .40
*Trade – SPY ($207.25) Buy the Feb 200/180 put spread for $2
  • Buy 1 Feb 200 put for 2.50
  • Sell 1 Feb 180 put at .50

Rationale – When doing portfolio hedges identifying possible inflection points in the market is important. The slow year end trading has given us an opportunity to enter these trades with lower vol as the market drifts higher into year end. All three trades look out to February and give time in case the market starts 2016 in a rocky fashion. In each case the trades risk about 1% for almost 10% of downside protection in case of a market correction.

IWM was 114.80, it is now 98.35. The put spread was 1.15, it is now worth 7.60. IWM is down 14% since entry and the hedge has offset nearly 6% in portfolio losses on that move.

QQQ was 114.20, it is now 100.25. The put spread was 1.15, it is now worth 6.70. QQQ is down 14% since entry and the hedge has offset 5% of portfolio losses on that move.

SPY was 207.25, it is now 186.70. The put spread was 2, it is now worth 10.50. The SPY is down 8.5% since entry and the hedge has offset 4% of portfolio losses on that move.

So all of these have worked the way they should and had the potential to alleviate much of the risk during this selloff if properly matched off against long holdings. Assuming a portfolio that looks somewhat like the SPX these 3 trades have made an 8.5% market decline feel more like a 3% decline. Not bad. That sure makes sleeping at night a lot easier.

But What Now?

Obviously none of these hedges are maxed out to their full potential. If the market kept declining that would happen, but they all max out at about 9% in portfolio protection. That’s great on a 10% market decline, but what if it turned into a 20% market decline, or worse? With the SPY hedge there’s still a bit of room to it’s lower put strike (lower strike is 180, SPY currently 207.25). But with the IWM and QQQ, both etfs are already towards their lower strike and in the case of IWM already below. That means those hedges have diminishing returns if the market were to crash from here. So for those that want to keep that protection on, it’s getting to the point to start thinking about rolling the strikes lower. So here’s how to do it:

IWM (98.50) – sell to close Feb 110/100 put spread at 7.60, use proceeds of 6.45 to buy March 95/80 put spread for 2.50
QQQ (100.25) sell to close the Feb 110/100 put spread at 6.70, use proceeds of 5.55 to buy the March 95/80 put spread for 2.10
SPY (186.50) sell to close the Feb 200/180 put spread at 10.50, use proceeds of 8.50 to buy the March 180/165 put spread for 2.90

Rationale – What we’ve done here is take off short deltas, book some profits from the hedges, and then reset the hedges lower. We’ve also moved them out to March, adding another month for the hedge. These new put spreads are essential portfolio protection against a crash from here as both would provide more than 10% in additional protection on top of how the closed hedges have already benefited.

What these types of tactical portfolio hedges also allow for peace of mind for those that want to start looking for entries in some stocks on the shopping list as the market goes lower. Most people have to sell when the market goes lower to protect gains, these hedges have done that for you. That means if the market goes even lower from here you are in a much better place than most to buy low.