COTW: Portfolio Hedging is Cheap Relative to History

COTW: Portfolio Hedging is Cheap Relative to History

The chart below can be downloaded here.

 

Over the last 27 years, the cost to hedge a U.S. equity portfolio using S&P 500 put options for declines larger than 20% (for 12 months) has ranged from 0.35% to over 15% of the value of the portfolio. Two-thirds of the time, the cost has been over 1% (median is 1.45%). Paradoxically, when the desire for hedging goes up – typically after periods of volatility – so does the cost, which then lowers the odds of a hedge having a positive payoff.

 

The opposite is also true. We looked at historical periods where the VIX was below 11.5 & the Shiller PE was above 22x. In roughly 50% of those cases, 12-month puts had a payoff that eclipsed 250% at some point in their life. While the study is based on a small sample size, it makes the case that if you plan to hedge at all, you should probably only do it when markets are calm & hedging is cheap.

 

 

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