Either Hedge Your Portfolio or Go Long

Predicting the market is very hard, near impossible in fact. That is why there are two choices when it comes to investing, hedging and going long. At first, the going long statement might be contradicting to the title of this article, but using historical data, you are more likely to be correct taking a long position than short.

Just think about it, do you remember when the Dow Jones was below 2000 points? How about 5000 points? The overall trend in US history is a very clear increase throughout time. Therefore if you take a long position, you are more likely to be correct than if you take a short position, for an extended period of time.

How do I trade? I personally hedge my portfolio. Hedging is simply the act of taking positions both ways for positive outcomes with either an up or down market. Hedging is tricky however, due to the fact that if you are “perfectly hedged,” your short positions will cancel out any gains of your long positions in an upward market and vice versa in a downward market. Therefore you have to get a bit clever with your hedging to show any real progress.

My personal approach is very simple, approximately 70% long on LEAP options (options that expire over a year from now), and the remaining put into shorter term put spreads against the market (usually using DIA, a Dow Jones Index). Focusing slightly on market segments (not specific companies) that I believe will do better for the long position.

Remembering that all of my options are highly leveraged, it just takes movement one way or another to obtain a gain. Let’s imagine 70% of my positions are long in ETFS (DIA, XLF, XLE, XLP, XLY, etc.) and 30% of my positions are put spreads against the market. These call spreads are set to more than double if the market moves downwards. The upward positions might have only 50% percent the same reaction if the market goes upwards.

If the market goes up:

  • My 30% short position falls in value to maybe 5-10% of value
  • My long position goes up by 50%, from 70% to 105%
  • I remain with 110-115%,
  • a double digits gain.

If the market goes down:

  • My 30% short position more than doubles to 70-75%
  • My long position goes down by 50%, 70% * .5 = 35%
  • I remain with 105-110%
  • My long-term positions are still in hand, while my short-term positions are liquidated and re-bought.

Now these numbers are fictitious obviously, but my strategy simply tries to use a smaller amount of leveraged money to cover losses from downward market movement. Also note that these short positions usually show a small gain or break even if the market doesn’t move at all.  I recently bought a Sept 13 151/150 put spread for $.39, which would give a gain of +156.4% if the market was below $150 by the expiration (Currently $150.50).

I will bring much more detail to my specific picks and strategies on this site in future posts. I believe that with options, you can obtain more consistent and higher returns year in and year out. This is my third year trading using this strategy, and it has treated me very well. Of course if I would of been completely long, I would of done a lot better, but the point of this strategy is to be more secure and avoid a complete wipe-out.

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