Cost of Hedging Weekly Update 11-19-13

by Jay Pestrichelli on November 19th, 2013

Despite the market hitting new all time highs, the cost of hedging has remained relatively unchanged over the past week.  As of the close of business on the 18th the short-term daily cost was 0.66 basis points per day and the mid-term cost out to June 2014 was 0.95 basis points per day.  
See data for the past 28 months on our Resources Page

Even though the market is pushing to new highs and the VIX has had a 12 handle on it the past 6 days, the cost of hedging has remained flat. To put it in perspective, these levels are still relatively low. Right now, for example, the Mid-term cost of .95 basis points per day means we can hedge a portfolio to stop loses after a 10% for 3.5% on an annualized basis. 
Many believe this low hedging cost is part of the reason why the market is not selling off. Locking in gains at these levels with a hedge at 3.5% helps investors avoid paying short-term capital gains and still locking in the profits of 2013. It also allows a portfolio to stay invested and continue to grow if the upward trend continues. Selling leaves a portfolio in cash and looking for some other place to go.
By this logic we can conclude that if volatility continues to stay low (i.e. keeping the cost of hedges down) there will be a lack of sellers to provide for any notable pull-back.  In addition, for those that invested earlier this year, it will make sense to hold out just a little longer until the gains go from short to long-term treatment. So we’ll expect dips in cost of hedging to be met with new buyers of hedges locking in gains and those buyers to hold onto their long positions that are profitable and now protected. All in all, we think that this gives one more reason to lean toward a bullish bias for the broad markets.

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