Cost of Hedging Weekly Update 1-9-13

by Jay Pestrichelli on January 9th, 2013

This week is more of the same as the cost of hedging has slowly drifted lower. The short-term costs sit at 0.98 bps per day and mid-term cost dips to 1.18 bps per day.
See data for the past 17 months on our Resources Page
Despite the VIX hitting its lowest levels since June of 2007, the cost of hedging is really leveling out. Most of this is due to the timing of the hedges. The VIX will give an indication of near term volatility of the next 30 days, but the hedges we're tracking are 3 or 6 months out.  

Don’t be mistaken, the cost of hedging is very low right now. If you’re looking to lock in certain levels, now is not a bad time to do it as options are cheap. The question to wrestle with is if you can put it off a little longer. Hopefully as a reader of this blog, you're already hedged and just trying to decide if now is the time to roll it forward or not. 

The risk of rolling to early is that you cover positions for time that you've already paid for. In other words, if you have March expiration  then rolling now would mean that you're covering the next 3 months twice as you've already most likely felt the loss of those hedges as the market has been up.  You may be able to move up the hedges, though, and lock in some of the territory you gained since they were created. That is going to be a position by position decision.

The risk of rolling too late is obviously that the price will go up on you. Not to mention the level where you establish your hedge might not be as favorable as you would get now. When we find ourselves in this situation, we find that moderation is the best policy since market timing is a difficult skill to master. By moderation, we mean spreading out the put rolling. Do some now and leave some in place. This should help you ladder out your protection and avoid a mistake from a single decision. 
Headline news for the next few weeks will be earnings and so far there are high expectations. We may hear decent outlooks from companies now that there is some certainty with taxes. Hopefully they won’t get caught up too much on the debt ceiling debate or the mandatory cuts that were put off till March and start to invest some of that cash sitting on their balance sheets.

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