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  • Hedging GLD: Before And After Its Recent Drop 0 comments
    Apr 13, 2013 5:36 AM | about stocks: GLD

    (Updated as of intra-day Monday)

    How You Could Have Hedged Your GLD Shares

    In late January, we posted two inexpensive ways to hedge 1000 shares of the SPDR Gold Trust ETF (NYSEARCA:GLD) against a greater-than-10% drop over the next several months. This was one of them:

    image

    As you can see at the bottom of the screen capture above, the cost of this put protection, as a percentage of position value, was quite inexpensive: only 0.77%. Note that, to be conservative, the cost here was calculated using the ask price of the optimal puts. In practice, an investor can often buy puts for a lower price, i.e., some price between the bid and ask.

    GLD has declined about 17% since January 25th's close, as of intra-day Monday.

    How Those Optimal Puts Reacted To GLD's Drop

    The screen capture below shows how those optimal puts we showed back in January reacted to GLD's drop as of intra-day Monday.

    As you can see in the screen capture above, those puts jumped more than 166% intra-day Monday when had GLD dropped 7.6% by the same time. This is an example of the nonlinearity of options, which enables a small dollar amount of put options can protect a much larger position in an underlying security, such as GLD.

    How That Hedge Cushioned GLD's Drop

    GLD closed at $160.65 on January 25th. An investor who owned 1000 shares and bought the optimal puts to hedge it against a >10% drop that day had $160,650 in GLD and an outlay of $1,230 on the puts (again, assuming, conservatively, that he bought the puts at the ask). $160,650 + $1,230 = $161,880.

    As of intra-day Monday, GLD traded at $133.15, and those puts traded at $15.20. As of intra-day Monday, our investor's GLD shares were worth $133,150 and his put options were worth $15,200: $133,150 + $15,200 = $148,350.

    So, although GLD dropped about 17% from January 25th's close to intra-day Monday, April 15th, an investor who bought those puts on January 25th was only down about 8.4% on his combined hedge + underlying stock position over the same time frame.

    More Protection Than Promised

    Recall that the optimal put hedge was designed to protect against a greater-than-10% decline. Because these had plenty of time value in addition to intrinsic value as of April 12th's close, they offered more protection than that.

    Hedging GLD Now

    The screen capture below shows the optimal puts, as of intraday Monday, to hedge 1000 shares of GLD against another, greater-than-10% drop by September 20th.

    As you can see at the bottom of the screen capture above, the cost of this protection, as a percentage of position value, was 3.79% - nearly 5x as expensive as it was to hedge against the same percentage drop back in January. It's still relatively cheap to hedge against a larger drop, though.

    *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 postdoctoral fellow at Princeton University's financial engineering department to sort through and analyze all of the available puts for your stocks and ETFs, scanning for the optimal ones.

    Stocks: GLD
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