Hedging Cost on the Rise

by Jay Pestrichelli on September 6th, 2012

If there is one constant about the market it’s that as the market starts to show signs of weakness, the price of hedging goes up. This is true for anything you’re trying to protect; whether it be a car or a home. If there is a greater chance of a mis-hap, the insurance goes higher.  I’ll add one corollary to that, which is short-term protection costs fluctuate greater than long-term.  This is the exact environment we find ourselves today.
Despite today’s big move in the market the volatility index, VIX, over the past 2 weeks has begun to rise, we can interpret that as the sophisticated money is starting to take a defensive stance. Up nearly 20% from 15 to 18 Tuesday, the VIX is telling us that near term volatility has a higher likelihood and we’re seeing the cost of hedging rise in step with it.
We track the daily cost of hedging on our Resource page.
This is not unexpected. We’ve posted over the last couple of weeks that the market should bounce in a range, but continue on an slow and steady upward trajectory as we approach the election.  That means some minor volatility along the way and taking advantage of hedging when the market is high and costs are low.
Rule # 1 of Buy and Hedge is Hedge Every Investment and if you’re just getting into the market now, those hedges are going to be a little more expensive than two weeks ago, yet on a relative basis, they are still affordable.  Especially because selling away some of the upside in the near-term will bring a higher premium.
So even though the market is pressing up against 4 year highs, the price of hedging is not as cheap as one would expect. Actually it was lower at the beginning of August. 

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