#1 What Didn't Work in 2012

by Wayne Ferbert on January 24th, 2013

#1 – What Didn't Work: Buying Puts
Buying a put is the equivalent of buying protection for your underlying position. It is a bearish investment. We use them as hedges at Buy and Hedge.
No one is going to look back on 2012 and say: “Gee, I wish my portfolio was hedged in 2012!” The markets were on an uptrend all year – with only a few brief respites in the middle. The rally is even continuing in to 2013.
But that is the nature of hedging. You don’t know when you are going to need it. By the time you wish you were hedged, it is always too late. The cost by that time is so high that you would never buy it – and more than likely the correction has already done its damage and nearing a turning point.
Look at Apple’s stock overnight. Buying protection for Apple today would just be too late – and seem like overkill given the discount that Apple now trades at to its earnings.
When you look back at 2012, the cost of being hedged kept declining as the year went on. The cost of buying longer term (6-12 months+) protection is still near record lows. The cost of buying out-of-the-money puts is mostly a function of market volatility. Volatility has been at consistently low levels thru most of 2012. The result: buying puts has been cheaper than most expected.
That was the good news. Unfortunately, as cheap as puts became, most of them still expired worthless in 2012 and have continued to lose value heading in to 2013.
But we press on as hedged investors anyway. We never know when we will need our hedges to kick in and save our portfolio. We only know that the laws of averages say that we will definitely need them eventually.

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