So far I have discussed how to
- Short against the box
- Exchange-traded funds (ETFs)
1. PairingPairing seeks to offset a position with a similar but not identical
- Industry/sector categorization (
"Industries vs. Sectors: What's the Difference?")
- Historic volatility (
2. Short Against the BoxSelling "short against the box" (SATB) is a unique hedging technique whereby a stock is hedged by short-selling the same exact stock (
4. Exchange-Traded FundsExchange-traded funds (
- The Spyders: Recalling that the sample portfolio had risk of $2,619,000 vs. the S&P 500 Index. The S&P 500 ETF, commonly called the "Spyders" (SPY), is a trust that replicates the S&P 500. The Spyders are now selling for about $153 per share. Thus, you can short 17,117 shares of SPY ($2,619,000 / $153) to hedge your sample portfolio.
- Sector-specific ETFs: If you are trying to hedge an individual stock, you may want to utilize a sector-specific ETF to achieve our risk management objectives. For example, I own CVS Caremark (CVS). CVS is a component stock in the Retail Holdrs ETF (RTH). I could hedge out some of my CVS risk by short-selling the RTH.
- Inverse and levered inverse ETFs: Whole new classes of negative correlating ETFs have been recently listed. These ETFs allow you to buy downside protection in an index. Using the SPY as an example, the Short S&P 500 ProShares (SH) and the Ultra Short S&P 500 ProShares (SDS) will appreciate as the SPX declines and will decline when the SPX increases. The SDS provides a double leverage impact on movements in the SPX.
- Selling covered calls: Selling a call against the position you desire to hedge.
- Buying puts: Buying put protection or insurance against your holding(s).
- Collaring: Simultaneously selling a covered call and buying a put to lock in a minimum and maximum potential sales price.