Ron Paul Vs. Paul Krugman: Hedging ETF Portfolios Inspired By Them

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Includes: GDX, GREK, SH, TIP, UDN, VTI
by: David Pinsen

Paul Versus Paul

On Tuesday, May 1st, Bloomberg TV hosted a debate between Texas Congressman Ron Paul and Princeton economist Paul Krugman. Dr. Krugman advocated stoking higher inflation to stimulate the economy, and Dr. Paul vigorously objected. A few days later, on Friday, May 4th, on Bloomberg TV's Street Smart program, Bloomberg ETF Analyst Eric Balchunas presented two portfolios of three ETFs each -- one inspired by Ron Paul's views, and the other inspired by Paul Krugman's views. Of these six ETFs, five had options traded on them. The table below lists all six ETFs, and the costs, as of Friday's close, of hedging the five optionable ones against greater-than-20% declines over the next several months, using optimal puts.

A Comparison

For comparison purposes, I've also added the costs of hedging the SPDR S&P 500 Trust ETF (NYSEARCA:SPY). First, a reminder about what optimal puts are, plus an explanation about decline thresholds. Then, a screen capture showing the current optimal put to hedge one of the ETFs inspired by Ron Paul, the PowerShares US Dollar Bearish (NYSEARCA:UDN).

About Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor 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.

Decline Thresholds

In this context, "threshold" is the maximum decline you are willing to risk. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I have used 20% decline thresholds for each of the names below.

The Optimal Puts For UDN

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of UDN against a greater-than-20% drop between now and December 21st. A note about this optimal contract and its cost: To be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal put. In practice, an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask (the same is true for the other names in the table below).

Hedging Costs As Of Friday's Close

The hedging data below is as of Friday's close, and is presented as percentages of position values. As we alluded above, there are no options traded on the Global X FTSE ETF (NYSEARCA:GREK), so it can't be hedged directly.

Symbol

Name

Hedging Cost

Ron Paul Portfolio

GDX

Marked Vectors Gold Miners

4.70%***

SH

ProShares Short S&P

0.82%**

UDN PowerShares US Dollar Bearish 0.73%***
Paul Krugman Portfolio

TIP

iShares Barclays TIP Bond

0.50%***

VTI

Vanguard Total Stock Market

2.70%***

GREK

Global X FTSE Greece

NA

Comparison ETF
SPY SPDR S&P 500 Trust 2.23%
Click to enlarge

**Based on optimal puts expiring in November

***Based on optimal puts expiring in December

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