Another Way to Hedge Against a Dollar Crash

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 |  Includes: SPY, UUP
by: David Pinsen

In his recent Seeking Alpha article ("Hedging Against a Dollar Decline"), contributor Mark Spiegel ("Logical Thought") referred to Fed Chairman Ben Bernanke's response to Rep. Ron Paul during last week's Humphrey-Hawkins testimony as an illustration of why Mark had decided to hedge against a dollar crash:

The fact that Bernanke appears to be smugly taking for granted the unconditional acceptance of our currency's current buying power makes me want to hedge against his monetary recklessness, but without buying gold (for the reasons cited in my aforementioned previous SA article, "At $1,300 an Ounce, Gold's Future Performance May Disappoint"). I chose to do this (even before Bernanke's comments last week) by purchasing a slug of far out-of-the-money SPY calls expiring December 2013 at a strike price of 210. I did this because if we do wind up with a dollar crash then ALL assets (including stock prices) will absolutely soar in nominal terms.

Another Approach

There is another way of hedging against a dollar crash than buying far out-of-the-money calls on the SPDR S&P 500 ETF ((NYSEARCA:SPY)): Buying optimal puts on the U.S. dollar index-tracking ETF PowerShares DB USD Bull (NYSEARCA:UUP). The table below shows the costs, as of Monday's close, of hedging against 10% and 15% declines, respectively, in UUP over the next six months, but first a reminder about what optimal puts are, and a detailed description of the PowerShares DB USD Bull (UUP).

Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. As University of Maine finance professor Dr. Robert Strong, CFA has noted, picking the most economical puts can be a complicated task.

With Portfolio Armor (available in Seeking Alpha's Investing Tools Store and as an Apple iOS app), you just enter the symbol of the stock or ETF you're looking to hedge, the number of shares you own, and the maximum decline you're willing to risk (your threshold - you can enter any percentage you like, but the larger the percentage, the greater the chance there will be optimal puts available for the position). Then the app uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones (click here for a step by step example).

More About UUP

PowerShares offers this detailed description of its dollar-index tracking ETF (UUP):

The investment seeks to track the price and yield performance, before fees and expenses, of the Deutsche Bank Long U.S. Dollar Futures index. The index is comprised solely of long futures contracts. The futures contract is designed to replicate the performance of being long the U.S. dollar against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc.

Hedging Costs as of Moday's Close

The data in the table below is as of Monday's close.

Symbol

Name

Decline Threshold

Cost as % of Position
UUP PowerShares DB USD Bull 10% 0.74%*

UUP

PowerShares DB USD Bull

15%

0.33%*
Click to enlarge

*Based on optimal puts expiring in January, 2012.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.