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Hedge with Time and Size First

Updated: Jan 26, 2022

Carrying a portfolio specific hedge can be costly. I have a 40% hedge in currently but that’s primarily because I’m not in the aggressive growth phase of my portfolio anymore. I’m okay with the carrying cost to reduce portfolio variance. That being said, if I were still focused on growth, I typically would hedge when I was leveraged. Otherwise, I’d simple use position sizing and increasing duration to reduce risk.

Hedging because we don’t like seeing red in our portfolio isn’t a great reason to initiate one. Many portfolios can survive swings simply by waiting (depending on the strategies deployed).

That being said, sometimes hedges are absolutely warranted and essential. Having a clear plan on your hedge is essential to optimizing implementation. A few questions I ask myself:

-What am I hedging and why?

>Most often, answer here used to be hedging my entire portfolio (sometimes individual positions) because of leverage or to reduce risk in an oversized position.

-How long do I want the hedge and is it dynamic?

>I almost always carry some short deltas however I do not perpetually carry a 20%+ hedge. Cost to carry isn’t worth it.

>I like to plan whether or not I intend to build positions and thus will want to increase my hedge. Or do I want to enter with a larger hedge and accept the hedge posing directional risk temporarily.

-What am I going to use to hedge?

>based on the first two questions I’ll either hedge via an index or options in an individual position. I try to use the current market to my advantage (selling premium in higher IV and buying in lower). For example, my current hedge is in VXX and VIX long calls (300+ DTE) that I bought when they were both below $20.

-Finally, what impact does the hedge have on my return and am I okay with it?

>Take a look at the cost of the hedge and see if it makes sense for your portfolio’s prospective return. If you’re pulling in 10% but hedge costs 6%, you may want to rethink the approach.

All in all, I find using time and size to reduce risk to be most efficient in most cases.

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