Cost of Hedging Weekly Update 2-12-13

Posted on February 12th, 2013

We’ve waited another 2 weeks between cost of hedging reports because, again, there hasn’t been too much to report. Hedging costs continue to drop as the markets show very few signs of concerns.  Here are the numbers: the short-term cost of hedging hit as low as 0.70 bps per day and the mid-term to 0.89 bps per day.
See data for the past 17 months on our Resources Page
The mid-term costs have dropped to a new low since we’ve tracked this data back to July 2011. Let’s dig into what this hedging trade would look like.

The SPX is trading at 1518 and one contract represents 151,800 worth of market value. If you are looking to create 10% downside protection find the put with a strike price 10% below the current price or about 1365. Using September’s expiration, 219 days out, we find there is no 1365 strike so we round to either 1350 or 1375.  In this case, since hedging is so affordable, let’s round up to 1375 and get a little more protection.
The SEP13 1375 Put can be bought around $32 per contract or $3,200 dollar cost.  This put will gain intrinsic value if the S&P fell more than 10% below the 1375 level and in doing so, will provide an offset to long positions that are losing money. This is why we consider it a hedge. For $3,200 you can build protection on $151,800 worth of market value.  This is about 2.1% or roughly 3.5% annually.
Ideally you want your hedges to lose money. That would mean that your underlying position is doing well. Managing the cost of these hedges is extremely important as this protection isn’t free and will drag on our overall returns. If that drag is only 3% many of us can live with that considering the alternative of having to ride a market down like most did in 2008.
If you feel the market it top heavy right now, hedging hasn’t been this cheap in a while, so consider putting in some protection. Knowing when the market is going to sell off is anyone’s guess and many will tell you there is a greater likelihood of the hitting 1350 before hitting 1650.

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