Getting Paid To Limit Downside On DUST
As hedge fund manager Tim Knight has noted (in this post last month, for example) precious metals and related securities remain in a multiyear bear market. As that bear market has continued this year in gold, gold miners, and ETFs that track them, shares of the Direxion Daily Gold Miners Bear 3x Shares ETF (NYSEARCA:DUST) have gained 116% year-to-date as of Monday, October 21st's close. DUST is quite volatile though, as triple-leveraged ETFs typically are, and that means it can move against longs fairly quickly. For example, DUST dropped about 23% in the last week, from October 14th to October 21st. For DUST longs holding gains from earlier this year, but wary of downside risk going forward, below is a way you can get paid to hedge.
Hedging With A Negative Cost Optimal Collar
Pays you to hedge, 15% upside cap.
If you're willing to cap your potential upside at 15% over the next several months (although, realistically, you probably wouldn't be in this position that long), this was the optimal collar*, as of Monday's close, to hedge 1000 shares of DUST against a greater-than-15% drop over the same time frame.
As you can see at the bottom of the screen capture above, the net cost of this collar was negative, meaning you would have gotten paid to hedge in this case.
Note that, to be conservative, Portfolio Armor calculated the cost of this hedge by using the bid price of the call leg and the ask price of the put leg. In practice, you can often sell calls for more (at some price between the bid and ask) and buy puts for less (again, at some price between the bid and ask), so, in actuality, an investor opening the optimal collar above would likely have netted more than $900 to do so.
Possibly More Protection Than Promised
In some cases, hedges such as the one above can provide more protection than promised. For a recent example of that, see this post about hedging the iPath S&P 500 Short Term VIX Futures ETN (NYSEARCA:VXX).
*Optimal collars are the ones that will give you the level of protection you want at the lowest net cost, while not limiting your potential upside by more than you specify. Portfolio Armor's algorithm to scan for optimal collars was developed in conjunction with a post-doctoral fellow in the financial engineering department at Princeton University. The screen captures above come from the Portfolio Armor iOS app.