Roll while the Rolling is Good

Posted on August 6th, 2012

After the 5% market rally of the last two weeks, there has been a notable drop in volatility as well as the cost of hedging.  Actually, after Friday’s pop higher, the short-term (76 days out) cost protective put costs hit the lowest level since we began publishing our daily data in July 2011.  Click here for the historical data from our Resources Page.
This data is compiled by calculating the daily cost of putting on a portfolio hedge using the S&P 500 index at a put level 10% below the current market price. While that level isn’t necessarily appropriate for all investors, it allows us to do a comparison on a level playing field. 

So what does a relative low mean for us? Well, while we’re not market timers at Buy and Hedge, we do have to pick from time to time when to roll protection. Since we follow Rule #1 which tells us to Hedge Every Investment,  from time to time, we need to reestablish our hedges.

In some portfolios, we actually rolled pieces expiring August and September protective puts forward to March. This allowed us to get some cash back for the puts that will expire worthless and apply to farther out puts that are trading cheaper than normal.

This may not be at the lowest of lows, but on a relative basis, it is cheaper than normal.  As a general rule, the price of these protective puts is closely correlated to the price of the VIX. No surprise that as the market rises, protection costs drop as does the VIX.
Oddly enough, as the market rose today, the VIX also rose 2%. One theory is that there are others out there doing the same thing we are and buying protective options. However, typically, the VIX is more a measure of speculation vs protection and it is more likely that traders are buying calls projecting that the market will continue to rise in the short term. Nonetheless, as hedgers we get the benefit of it as the market rises.

Bottom line, consider taking advantage of cheap hedging prices while they last. Let’s face it, August and September hasn’t been kind to the long-term investor these past few years and taking advantage of these market prices might be the best way to sleep well going into Labor Day.

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