36 lines
2.4 KiB
Plaintext
36 lines
2.4 KiB
Plaintext
Chapter 30: Stock Index Hedging Strategies 543
|
||
With the futures having been eliminated as a possibility, the investor must now
|
||
choose which strike to use. Since he will be selling calls and buying puts, and since
|
||
either strike allows him to synthetically sell the UVX "future" at 178, he should
|
||
choose the 180 strike. This should be his choice because the 180 calls are out-of-the
|
||
money and thus less likely to be the object of an early assignment.
|
||
HEDGING WITH INDEX PUTS
|
||
Let us now move on to discuss ways of hedging in which a complete hedge is not
|
||
established, but rather some risk is taken. The main difference between options and
|
||
futures is that futures lock in a price, while options lock in a worst-case price (at
|
||
greater cost) but leave room for further profit potential. To see this, consider a long
|
||
stock portfolio hedged by short futures. In this case, one eliminates his upside profit
|
||
potential except for positive tracking error. However, if he buys put options instead,
|
||
he expends money - thereby incurring a greater cost to himself than if he had used
|
||
futures - but he still has profit potential if the market rallies.
|
||
One could hedge a long stock portfolio with options by either buying index puts
|
||
or selling index calls. Buying the puts is generally the more attractive strategy, espe
|
||
cially if the puts are cheap. In order to properly establish the hedge, it is not only nec
|
||
essary to adjust the dollars of stock in accordance with the Beta, but the deltas of the
|
||
options must be taken into account as well. The following example will demonstrate
|
||
the use of puts to hedge a portfolio of diverse stocks.
|
||
Example: Assume that an investor has the same portfolio of three stocks that was
|
||
used in a previous example: 3,000 GOGO, 5,000 UTIL, and 2,000 OIL. He has
|
||
become somewhat bearish on the market in general and would like to hedge some of
|
||
his downside risk. However, he decides to use puts for the hedge just in case there is
|
||
a further rally in the market.
|
||
The table from the earlier example is reprinted below, showing the adjusted
|
||
volatilities and capitalizations for each stock in the portfolio. The total adjusted cap
|
||
italization of the portfolio is $720,000, as before.
|
||
Adjusted Adjusted
|
||
Volatility Quantity Capitalization
|
||
Stock Volatility (Step l) Price Owned (Step 2)
|
||
GOGO .60 4.00 25 3,000 $300,000
|
||
UTIL .12 0.80 60 5,000 240,000
|
||
OIL .30 2.00 45 2,000 180,000
|
||
Total adjusted capitalization: $720,000 (step 3) |