introduction to hedging: protection in uncertain …...technical indicators are giving bearish...
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Introduction to Hedging: Protection in Uncertain Times
Fidelity Brokerage Services, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917. © 2016 FMR LLC. All rights reserved. 708601.4.0
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Disclosures Options’ trading entails significant risk and is not appropriate for all investors. Certain complex options
strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options, and call 800-544- 5115 to be approved for options trading. Supporting documentation for any claims, if applicable, will be furnished upon request.
Examples in this presentation do not include transaction costs (commissions, margin interest, fees) or tax implications, but they should be considered prior to entering into any transactions.
There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, and collars, as compared with a single option trade.
The information in this presentation, including examples using actual securities and price data, is strictly for illustrative and educational purposes only and should not be construed as an endorsement or recommendation.
Trailing Stop orders are monitored between 9:30 AM and 4:00 PM Eastern Standard Time and are maintained on a separate order file on a “not held” basis until triggered, at which time they are sent to the marketplace. Additional information about Trailing Stop orders is available at Fidelity.com (link: https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/Conditional_Orders.pdf)
ATP: Active Trader Pro PlatformsSM is available to customers trading 36 times or more in a rolling 12-month period.
P/L Calc: Profit probability shows how likely a particular option trade (or combination of trades) will be profitable, based on a calculation that takes into account the price of the trade and the expected distribution of stock prices based on the 90-day historical volatility.
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Goals of Today’s Presentation
Help grasp the general concept of hedging and the different methods that could be used
What we will cover:– What is hedging and why do trader’s do it– Stop, Trailing Stop, and Conditional orders– Protective Puts– Beta… what is it?– Collars
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Whatishedging? Protectingasecurityand/oraportfoliotominimizetheimpactofanadversemove.
Whydotrader’shedge? Concernwithrecentvolatility,butstillbullish
Overallmarketorsectorweakness
Shiftinfundamentalinformationthatcausedyousomeconcern
Technicalanalysisisprovidingpossiblebearishsignals
Taxsituationisnotfavorabletoliquidateatthispoint
Trader’sView:Hedgingisnotthesameasspeculation.Hedgingisusedtoprotectfrom,notprofitfrom,anadversepricemove.
IntroductiontoHedging
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Dormantmarketorderuntiltriggeredbylasttradeatorbelowthedefinedprice(viewedbythemarket)
Dormantlimitorderuntiltriggeredbylasttradeatorbelowthedefinedprice(viewedbythemarket)
Movingdormantmarketorderwherethetrigger/stopisdefinedbypercentageorspecificamountfromthedefinedtrigger(last,bid,ask)(inhouse)
Movingdormantlimitorderwherethetrigger/stopisdefinedbyapercentageorspecificamountfromthedefinedtrigger(last,bid,ask)(inhouse)
Theseorderscanalsobeused,andtriggeredbasedonanynumberofcriteria
Trader’sView: Pricealertscanbesetupasanalternativetousingastoporder
OrderTypesUsedtoManageEquityPositions
Stoploss
Stoplimit
Trailingstoploss
Trailingstoplimit
Conditionalorders
‐Triggerpricespertaintoequities
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Securitygappingcouldcauseamuchdifferentresultthanwhatwasexpectedfromthestoporder.
EnemyofStopOrders:GappingRisk
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Advantages: Lowcost(commission) Automaticallyclosestheposition Disciplinedtradingprocessreducesemotionaldecisions Attachesprice,orpercentage,todefinelossthreshold Exitpositionwhenimportantsupport/resistancelevelbreachedDisadvantages: Gappingrisk(forstoporders) Orderneverexecutingbecausethesecurity
continuestomove(stoplimits) Liquidateatunfavorabletime(taxsituation,
triggertooclose)
StopandTrailingStopLoss/Limitbreakdown
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Ahedgecanbeanythingthatgainsvalueasthepositionyouareconcernedaboutislosingvalue.
Atruehedgedefinesthepotentiallossonalongposition. Themoreseparationbetweenthepositionofconcernanditshedge,thelesseffective
thehedgewillbe
Therearemanypopularwaystohedge:
1. Usingputcontractsonindividualpositions2. Usingputsonanindexasaproxyforaportfolioorsubsetofaportfolio3. Goinglongsecuritiesthathaveahistoryofmovingintheinversedirectionofthe
position
WaystoHedge
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Premiumisspenttopayforprotectiononsecurityorindex,putsincreaseinvaluewhenunderlyingdecreasesinvalue
Trader’sView:Hedgebeginsatbreakevenofputs(Strike– Premiumpaid).Rememberyoupaidapremiumtohavethehedge.
Advantages: Actsasatruehedge Thecontractholdercontrolsif/whenthecontractisexercised Allowmoreflexibilityformanagingindividualtaxsituations Nogappingriskwhilethehedgeison
Disadvantages: Costtoestablishandmanage– Increasesbreakevenontheposition Oftencostsmorewhenthetrue“need”arises Timetomanage Requiresanunderstandingofamorecomplexfinancialinstrument
BuyingPutstoProtectPosition/Portfolio
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Assumeentry@$92.76on4/17/14
Hedgeestablishedwhileunderlyingis@$96.63on7/31/14
UsingJan2015$95Puts@$3.95
Supportidentifiedaround$94.00
BuyingPutstoProtectPosition/Portfolio
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BuyingATMprotectiveputsdefinesthelossontheposition
Maxlosstothedownsideisnowlimitedto$174.00
Breakevenincreasesto$96.71
from$92.76
Unlimitedprofitpotentialremains
BuyingPutstoProtectPosition/Portfolio
Trader’sView:Makesuretoprovideappropriateduration.Remembertheclosertoexpiration,thehigherthetimedecaywitheachpassingday.
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HedgedPosition:
LossLimitedto$174
UnhedgedPosition:
Lossof$13.13/share=$1313totalloss
Entry@$92.76on4/17/14
Currentprice$79.63
BuyingPutstoProtectPosition/Portfolio
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Forlargerportfolios,sometrader’swilluseputsonanindex orETF asahedge MostcommonindexorETFtohedgeportfoliosistheS&P500(SPY,IVV)– otherindicesmaybemore
appropriatedependingontheportfolio Notexact,riskoftrackingerror
Buyingputsforeachindividualpositionsprovidesthemosteffectivehedge,butisusuallymoreexpensiveandrequiresmoretimetomanage
Tocalculatethe#ofcontractsneeded,takethecurrentvalueoftargetassettohedgedividedbytotalmarketvaluethattheputscover(usuallyStrikePrice*100)
Forexample:Atthetimeofthiswriting,theS&P500wasat2050.EachATMcontractcovers$205,000(2050*100).Acloselycorrelated$1,000,000equityportfoliocouldbehedgedwith5putsontheindex.
Trader’sView:IfusingindexorETFputcontracts,considerthedifferencesinexercisestyleanddeliverableonthecontracts
BuyingPutstoProtectPosition/Portfolio
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Measuresthesensitivityofpricechangeofanunderlyingcomparedtoabenchmark ABetaof1.00meanstheasset’spricesmovetogether ThemostcommonbenchmarktradersuseistheS&P500butbetaweightingcanbedone
betweenany2assets Betaisnotastaticmeasure,itisconstantlychanging
S&P 1%
Beta= 2
Security 2%
S&P 1% Security 2%
Trader’sView: Betaweightingtheportfolioallowsatradertoadjustthehedgetobecomemoreeffective,butbetaisconstantlychanging
Beta…Whatisit?
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Collar:BuyingaprotectiveputandreducingthecostbysellinganOTMcall Limitsupsidegain,butreducesthecostofthehedge
Trader’sView: Aputspreadcanalsobeusedtoreducethecostoftheprotectiveput,butitonlyprotectsthepositiondowntotheshortstrike
Maxlosstothedownsideisnowlimitedto$74.00– lowerthantheprotectiveputduetopremiumfromthecall
Breakevenislowerthantheprotectiveput:$95.71vs$96.71
Tradeoff:Maxgainisnowlimited
Collars
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StopOrders ProtectivePuts IndexPuts Collars
Cost Costofacommission
Mostcostly,individualpositionbasis
Usuallylesscostlythanbuyingonindividual
positions
Sellingthecallreducesthecostofthehedge
Upside Unlimited Unlimited Unlimited Limited
Effectiveness Doesnotserveasatruehedge
Mosteffectiveduetodirectrelationshipwith
theunderlying
Effectivenesswillvarydependingonlevelof
correlationbetweenindexandthestockportfolio
Mosteffectiveduetodirectrelationshipwith
theunderlying
EaseofManagement
Dependentonthenumberof
positions– mayrequiresignificantorlittleeffort
Mayrequiresignificanttimeandeffortto
manage
Generallyrequirestheleasttimeandeffortto
manage
Mayrequiresignificanttimeandeffortto
manage
IntroductiontoHedging
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Hedgingisdonetominimizetheimpactofanadversemove: Shorttermvolatilityexperiencedwithbullishoutlook Overallmarketweakness Liquidatingwouldcreateunfavorabletaxsituation Shiftinfundamentals Technicalindicatorsaregivingbearishsentimentbutlongtermoutlookbullish
Stopandtrailingstoporderscanhelpmanageriskforthecostofacommission,butdonotserveasatruehedge
Protectiveputsserveasaneffectivehedge,butatthecostofthepremium
Thestrongertherelationshipbetweenthehedge,andtheassetitisintendedtoprotect,themoreeffectivethehedgewillbe
Collarsallowsformorecosteffectivehedgesatthecostofupsidepotential
KeyTakeaways
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IntroductiontoHedging