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How to Hedge Your Emerging Market Longs

As the markets get increasingly elevated and overpriced, I am widening my search for cheap disaster insurance. Today I’m looking at a hedge for those with substantial emerging markets exposure, which pretty much should be everyone who reads this letter. Take a look at the Direxion Daily Emerging Markets Bear 3X Shares (NYSEARCA:EDZ) (click here for details), which is a triple inverse ETF on the emerging stock markets. In theory, a 10% drop in the emerging markets would produce a 30% gain in the ETF. In reality, the trip can be much more rocky. To say these markets have simply gone up is a gross understatement. The major components of the EDZ include short positions in shares from China, which has risen this year by 94%, India, up 95%, Brazil, up 116%, and Russia up a mind boggling 183%. No surprise then that the EDZ has had its face ripped off, down a gut churning 92%. You can buy $33,000 of EDZ to imperfectly hedge $100,000 worth of emerging market longs, or scale in here at $5 with a view to a quick double early next year when the inevitable profit taking hits. I’ll throw in a cautionary warning that if we enter a prolonged period of grind sideways, the EDZ could very well get dragged down to zero by its internal cost of carry. In flight school they always teach you to wear a reserve parachute when engaging in high level aerobatics. Best to apply this philosophy to your portfolio.