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I really like the hedging technique to protect my portfolio against melt downs of the market. We have used buying calls of QQQ. My questions:
Is it advisable to target for a ratio of 1 contract for every $100,000 invested? Should this number go up if the portfolio is heavy in AI ?
What is the ideal strike time? We have been using 3 months for our contracts but would it be advisable to buy more contracts every 6 weeks for exemple? Like some kind of ladder…
Thanks for your help. A.M.
Hi A.M. – great questions.
With all of the normal caveats that we can’t give specific advise for any individual investor, I can tell you how we approach our hedging process in The Trading Club. That is, we’re targeting a ratio of about 50% of the portfolio capital for our hedge. So in this case, the 1 QQQ Put at the $600 strike price is the equivalent short exposure of $60,000 in the QQQ, which is about 50% of our total portfolio capital. We generally aren’t looking to hedge more than 50% of our exposure as that would involve paying more for options premiums over time, and quickly becomes prohibitively expensive unless our market timing is perfect (something we don’t want to rely upon in our overall strategy).
However, as you allude to, we don’t have much exposure in the technology sector that we view as the most at risk in today’s market. A lot of our portfolio is in defensive assets that we believe should hold up relatively well in a tech-led bear market. But hypothetically speaking, for a portfolio that’s heavily exposed to technology, it could make sense to use a larger QQQ hedging position to offset that risk – but that’s ultimately a decision that each investor must make for themselves based on their personal risk tolerance and overall trading process.
As far as the timing, we’re generally placing these hedging trades on a quarterly basis to overlap with the quarterly cadence of our option sales. The trade off here is that shorter duration contracts are cheaper, but they also expire at a faster rate. So here again, if your timing is impeccable, then buying shorter duration contracts offer a higher pay off in the event of a crash. But since we don’t want to rely on our ability to time the market, we think a balanced approach is to buy and sell options around the same quarterly interval.
Thanks,
Ross
TY for clear and straightforward comments.A.M.
Shorts have an unlimited loss potential as prices rise. It becomes especially acute if one is not able to cover their short and losses continue to expand. It’s been quietly reported major banks hold massive silver shorts off balance sheet that have kept the price of silver in check for decades. With the recent historic breakout of silver due to the supply/demand imbalance, is it conceivable we are now seeing the very beginning of the ULTIMATE short squeeze that could be the trigger for a major economic downturn ?
I’ve heard various theories about the big banks and silver shorts over the years, but never seen any definitive proof one way or the other.
All I can say is that if some group was working together to keep the silver price suppressed, they’ve done a pretty lousy job!
Here’s one example of past manipulation: https://www.cftc.gov/PressRoom/PressReleases/8260-20
The Trading Club has been an excellent source for learning about different types of trading and analyzing a variety of companies. For too long, I have been solely focused on metals & energy.
That being said, I closed the recommended Sell Call on SLV at $60. I’ve followed silver for too long to take short profits on this position. The wild Jan 16 call options on SLV, along with other strange happenings ( China closing silver exports in Jan, large OI in Comex standing for delivery, CME shutting the metals market for 10 hours after Thanksgiving, ect..), leads me to believe much higher prices are coming. Going to let this winner run for awhile.
The Bank Participation Report for 11/4-12/2 was posted on the CFTC site yesterday and Ed Steer published this morning that the big five US bullion banks are now NET LONG in silver, for the first time ever. What has been going on in December will not be reported until Jan 9. The suppression game in silver looks to have changed.
Morning Ross,
Are the following Companies on your watchlist for trading ideas:
TPL, VG, REMYY
Your thoughts?
Boone
Hi Boone,
Yes, I’m actively monitoring each of these stocks as potential opportunities. A quick few comments on all…
TPL is a tremendous business, but it overlaps significantly with our already-heavy VNOM exposure. Another factor is that the share price is too high for us to effectively use options to generate income.
For VG, I view this a highly asymmetric opportunity at current prices. It has elevated downside risks due to the ongoing arbitration procedures that could result in a potential multi-billion dollar liability, on top of an already-stretched balance sheet. If the company manages to reach settlements that avoid a worst-case outcome, it could become very interesting. For now, I’m happy to wait on the sidelines, but we may consider it as a potential trading idea down the road.
As far as Remmy, Porter made a very compelling pitch for this company based on the value of its existing inventory alone. However, the challenge here is that we cannot get access to the options on the stock due to the fact that it trades as an ADR. In the current market, I’m leaning towards focusing on stocks where we can sell options to generate income, given my concerns about the risks of a broader bear market.
Hope that helps.
Thanks,
Ross
For the NKE trade, why buy the stock outright vs. selling a put and buying a call?
Loving the service!
Thanks,
Justin
Great question.
And yes, this kind of “risk reversal” can be a powerful trade for expressing a bullish view. However, the key thing to remember about options is that the majority expire worthless over time. So when it comes to trades like this that involve buying calls, we try to focus exclusively on stocks or ETFs that have a clear catalyst for higher prices in the near-term.
So for example, we bought BTI calls based on the view that the success of the company’s new VELO Plus pouches will provide a near-term inflection for the shares. Similarly, with our CLBT risk reversal trade, we expect the resumption of growth in new federal contracts should provide a boost to earnings and the share price next year.
For stocks without a clear near-term catalyst, we view selling calls or puts as the more optimal trading strategy. And we believe Nike falls into this category, as it’s undergoing a long-term strategic shift in its business model that will likely take many quarters to show a meaningful improvement in its sales and profit margins.
Of course, that doesn’t mean we can’t be wrong. Yesterday, it was reported that Apple CEO Tim Cook made a $3 million purchase of Nike shares, which sent the share higher by 5% this morning. Sometimes a turnaround stock that’s been beaten down to the degree Nike has in recent years could stage a powerful rally as investors regain confidence in its outlook.
But for now, we plan to focus on selling calls, and/or possibly adding to the position by selling puts, until we see the turnaround effort translate into a meaningful improvement in the company’s financials.