Cost of Hedging Update 9-23

by Jay Pestrichelli on September 24th, 2013

The news of the absence of a taper in the Fed’s QE program has given investors an extension of the Bernanke put and reduced market volatility since our last update.  As of the close of business on the 23rd  the short-term daily cost was 0.80 basis points per day and the mid-term cost out to March 2014 dropped to 1.00 basis points per day.  
See data for the past 27 months on our Resources Page

After the Fed’s announcement to delay any reduction in its bond purchasing program, the market soared to new highs and volatility had a pull back. As we know, a lower volatility means a lower cost of hedging. Unfortunately, we did not see a dip down to the levels we saw last time we hit new highs. On August 2nd the cost of hedging in the short term dropped to 0.60 basis points per day. However this time it bounced off of 0.70…and did it quickly. If you blinked you would have missed it.
 
The market interpreted the Fed’s lack of action change as a sign the economy is too weak to handle an ease off the “easy-money” accelerator.  Once investors realized that unfortunate fact, the market began to immediately retrace. Add to that the talk of another debt ceiling debate and we saw investors not feeling as bullish. In the options market we saw hedgers locking in the gains by purchasing protective puts.
 
Have no fear; however, you are not too late to the game. If you think this market has topped out in the short or medium term, hedging costs are still relatively low. Many are finding buying a portfolio put more favorable to just selling. Buying protection out to March right now (at a 10% level below the market) will cost about 3.6% or 1 basis point per day. With a market that is up over 20% YTD, it’s never a bad thing to lock in some of these gains with protection. Purchasing a put wouldn’t stop form experiencing additional growth either. Compare that to selling your long holdings. Yes you save on the cost of hedging, but that action prevents you from experiencing additional upside growth.
 
When investors call the QE program the Bernanke Put, they are referencing that the action of the Fed will prevent too much of a sell off.  If the Fed does decide to taper this year the theoretical put protection of the Fed will start to fade like we saw in June. Our advice, stay ahead of it and get yourself some protection on your own in advance.


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