hey YouTube I'm Jimmy in this video I'm
gonna walk through hedging a stock
portfolio and we're gonna look at how it
could go about saving us a fortune I'm
going to examine some of the most
popular forms of hedges and then we're
gonna look at their actual track records
based on some of the more recent market
Corrections now
I recently did a video called five tools
to predict a stock market crash and in
that video I mentioned that if you are
afraid of a market crash or even a
pullback well you can always head your
portfolio and then one of the
subscribers posted a comment and he said
how would I go about setting up a hedge
and I thought well that could really
make a great video since it could save
investors a ton of money and since we
care about how executable something like
this would really be I decided to
analyze different hedges and how
strategically they could be used in
today's actual environment and to do
that we're looking at some of history's
more recent collapses okay so here it is
so first let's start with the very
basics what is a hedge well at its core
a hedge is something you would add to
your investment portfolio that in theory
you should profit if one of your assets
goes down Vanessa should profit so
theoretically diversification is
striving to do the very same thing in
fact diversification would be a form of
a hedge because imagine you won't let's
say nothing but energy companies and
then oil collapses like it did back in
2015 well if you only own energy
companies your portfolio is going to get
crushed now I did a whole video on
diversification so if you haven't seen
that or if you're not sure what
diversification is that might be a good
place to start and you can see a link to
that in the description below
but for the case of this video I'm going
to assume that you have a diversified
portfolio I'm going to assume it's all
US stocks and we're going to look to set
up hedges we're gonna examine which
hedges will be best assuming we have a
u.s. stock portfolio so first let's look
at gold gold is a very popular hedge
here's a price chart 5 years looking
back at what gold is done recently
so my first observation is that gold
appears to be quite volatile and perhaps
that's ok especially since the price of
gold is down recently to run around
$1200 and we could see that not too long
ago it was slightly above 1350 and and
that was only in April of 2018
so the concept behind gold being a good
hedge is that it's a defensive play
particularly against inflation and often
times when the market Falls investors
retreat to what they deemed to be a
safer investment in gold from many
investors is often near the top of that
list so the test if gold is really if it
really works as a good hedge then what I
did is I examined gold relative to three
significant market pull backs in recent
history
so the first pullback I'm going to look
at is the oil collapse that lasted from
mid 2014 till early 2016 and if you
don't remember well oil fell from a high
up here of about 107 dollars of barrel
to about $26 a barrel in early 2016 now
if we had the S&P to that we can see
that SP didn't do as bad as oil did but
you can see that SP didn't exactly do
great during this time that's why I'm
including it so now what happens when we
add gold so to keep this chart from
getting too cluttered I'm actually
eliminating oil we're keeping the
timeframe but we're just gonna eliminate
oil so the orange line is the S&P 500
the green line is gold and as you can
see gold actually didn't do that great
during this time period but what's
interesting to note is that when we zoom
in a bit we can see that on more
volatile days like right here
well the SP fell in gold sharply went in
the other direction and then
happened a few times now this particular
market correction may not be the best
example for gold since oil is a hard
asset and gold is also a hard asset and
in theory they may not act terribly
different from each other although this
was a very oily pull back but frankly
we've been in a long bull market so it's
been tough to identify pull backs that
being said our next one we went back to
await to see what happened with gold in
the Great Recession so for the ohwait
collapse we're gonna take from about the
middle of May in 2008 which is right
near the market high and we're gonna go
push forward till about March of 2009
which was right near the market low now
when we add gold for that same time
period well once again we can see that
gold was very volatile much like it was
when we were looking at the oil collapse
and it did end the whole period from
here to here higher which means that if
it was in your portfolio as a hedge it
would have helped offset losses although
it would have been a very volatile ride
as you can see during the whole thing
and to me it's interesting that these
two charts the sp500 and gold almost
look nothing alike
I mean gold at different times is moving
higher while the SP was moving lower but
then they were also moving together at
the very same time if you look at this
area so for me they seemed somewhat
uncorrelated okay so now let's jump back
to the tech bubble back in 2000 this
chart goes from the high in about March
of 2000 to the low which happened in
October of 2002 now this is what a hedge
looks like frankly I was sort of
expecting this type of chart back in the
Oh it collapse and as we can see here as
the S&P 500 fell gold rose and it looks
like gold reacted as you would expect a
hedge to act when the market is pulling
back when the SP boosted higher in any
one moment gold fell and vice-versa so
in this scenario looks like gold was
more beneficial since it looks to be
more negatively correlated so now
there's a quick way to see a summary of
how gold
benefitted each portfolio if you look at
this table here you can see that the
correlation is negative for each of the
three market Corrections that we looked
at between the sp500 and gold and as I'm
sure you could have guessed from the
charts the tech bubble was be most
negatively correlated which in theory
would mean that would have benefited the
portfolio the most although because each
one was negatively correlated that would
really be a good thing as a hedge so
overall it looks like gold would provide
hedge benefits to a stock portfolio at
least according to these three market
Corrections okay so for our second hedge
we're gonna look at cash now you might
not think of cash as a hedge but I'd be
willing to guess that this is probably
the most popular of all hedges and it's
probably my least favorite as well so
what I mean by cash is I mean that
you're afraid of a market pullback so
you sell all your positions and you hold
cash instead now if you think about it
from that perspective then perhaps you
can see how cash could be used as a
hedge basically your forfeit upside
since you're no longer invested and in
return you don't have any downside risk
also since you're not invested but since
we're investors you might also guess why
don't really like this strategy to me
this is market timing sure going to cash
is great if you're right about it but
when you're wrong well then you're just
sitting on the sidelines and to me that
doesn't make any sense
see if I had a crystal ball and I knew
the market was gonna get cut in half
tomorrow well even then I wouldn't go to
cash I would probably buy a put option
or something else some other way that
perhaps I could turn my knowledge that
this is going to crash into some profit
and this brings me to our third possible
hedge which is also my favorite using
put options so if you're not sure what
put options are you can see my I did an
investing basics video and you can see a
link to that in the description below
now basically if you buy a put option
you profit when the underlying security
now how the best way to actually execute
this type of strategy would vary from
portfolio to portfolio depending on what
each portfolio had in it but for our
sake let's imagine that you only had one
investment and that investment let's
pretend you owned an ETF tied to the S&P
500
well in this case hedging is a bit
simpler because you only have one
holding and if we were to go out and buy
put options on the S&P 500 ETF then in
theory that would hedge our entire
portfolio so let's have a look at how
that would work so for our example I'm
going to imagine that we own s P Y which
is a spider SP 500 ETF now as I shoot
this video the SP Y is trading at about
280 $3.75 and where we bought SP Y is
somewhat irrelevant since in this
example I'm gonna walk us through what
were to happen from what would happen
today forward so if you bought that at
$100 good for you you're up huge but my
real concern is what is it going to do
from here forward so that's why I'm
somewhat ignoring what our cost was for
us where we are today - what we do with
the put options how does it look now the
key with put options the thing to
remember is that when you buy them you
pay a premium today and in return for
that premium you have the right to sell
100 shares in this case of SP y at a
predetermined price called the strike
price by a predetermined date they call
that the expiration date so based on the
current price let's look at some real
examples and for the sake of keeping the
numbers real let's imagine that we own a
hundred shares of SP baht so right now
our hundred shares is worth twenty eight
thousand three hundred and seventy-five
dollars and since options trading groups
of 100 will only need one option so
today's date the data I'm filming this
it's August 14th 2018 and once again SP
y is currently trading at about two
hundred eighty three dollars and seventy
five cents so let's pretend that I think
a market collapse is about to happen I'm
certain of it the crystal ball she told
me that the collapse is going to happen
yeah I made
Cristobal girl so perhaps I'm so
confident that a crash is coming that
I'm going to go ahead and buy put
options that expire in the middle of
September just a month away
[Music]
so here the prices for the September
options and when you look at an options
quote you can see that it's quoted per
share so if I wanted to buy the $283
puts I pay two dollars and sixty five
cents which is $265
now before we analyze the individual put
option choices
my concern is obviously the accuracy of
my crystal ball I love her but she's
been wrong before so what if she's wrong
again so to protect myself a bit I'm
gonna consider going out a bit further
as far as time is concerned so now I've
added the prices for January of 2019
which is just a few months away and also
the prices for put options that expire
in September of 2019 so when we look at
these prices obviously the first thing
that jumps out to me is the how
dramatically the prices increase so if I
buy the September of 2019 puts I'm
paying fifteen hundred and ten dollars
for put options with a $280 strike price
so let's plug that one out for a second
just so we can see how this would work
if we were to add these to our portfolio
today so we buy this put option this one
put option gives us the right to sell
our 100 shares of SP y at $280 and for
that right we're willing to pay the
seller of the put option fifteen hundred
and ten dollars today so scenario one
the market doesn't fall in fact it keeps
moving higher
[Applause]
okay so let's imagine on the day of
exploration yes spwhy is trading at $300
a share okay interesting
now scenario two same day in the future
but instead she was right yes sp why did
fall and it's down to two hundred and
fifty dollars a share let's look at how
these scenarios play out so in Scenario
1 the market moved higher and SBY on the
day of exploration is currently trading
at $300 a share well we spent fifteen
hundred and ten dollars to protect us on
the downside and it turned out to be
unnecessary so instead of our portfolio
being worth thirty thousand dollars
which is the $300 per share times on 100
shares that we own well it's only worth
twenty eight thousand four hundred and
ninety dollars which is we can thank the
fifteen hundred ten dollar expense that
we added so in this case the hedge
turned out to be nothing more than an
expense okay
now on the flip side in scenario 2 s py
fell down to two hundred and fifty
dollars per share so are two hundred and
eighty dollar put options are now thirty
dollars in our in the money so I'm going
to assume that they're going to be worth
thirty dollars and that would mean that
the value of the put on the day of
expiration is three thousand dollars but
we still paid the fifteen hundred ten
dollars to get that right so instead of
the portfolio only being worth twenty
five thousand that it would have been
worth without the hedge well it's
actually worth twenty-five twenty-six
thousand four hundred ninety dollars now
this brings us to another important
point when considering how to put on a
hedge this particular put option was $30
in the money when it fell from two
hundred eighty down to two hundred fifty
and that's quite good but because we've
selected a put option that was so far
away as far as time is concerned a lot
of the value of that fifteen hundred and
ten dollars that we paid was time value
and if our scenario let's pretend our
scenario had ended just a week after we
bought the put option well most of the
time value would have still been in
place and we could say that the put
option would have been worth let's say
$40 per share we still would have spent
the fifteen ten but if it had happened
sooner it would have been worth
significantly more so another option
that I've seen work out for people
is to buy shorter-term options and keep
rolling them over so in our original
example if we look at the original
prices that we had pretend that we
didn't buy this one but instead we
bought this one which expires in a few
months in January of 2019 don't forget
it's currently August so just a few
months away well then we're paying only
seven dollars and 85 cents which is $780
five dollars for the whole contract now
if the pullback happens during that
while our profit will be even larger
assuming the same pullback happened but
let's pretend during that time period
the market actually keeps climbing
higher and we're still worried about a
pullback and instead of the current
price currently being 283 75 which is
where it is today
pretend in December the it's trading at
293 well where we bought the $280 put
options here in theory we could buy the
290 dollar put options in December
before this one expires so we always
remain hedged
[Music]
so the wrap-up put options as a hedge
well you can see that there are many
different ways to use put options to
work in your favor now I used a super
basic example where your entire
portfolio was one holding which seems
very unlikely most people probably
wouldn't have that but let's imagine
that you're holding stocks like Facebook
and Netflix and Amazon and you can say
that you know these holdings represent
30 40 or 50 percent of your portfolio
well you could always buy options on
just those three holdings because then
in theory your largest holdings would be
hedged or perhaps you find an ETF that
has each of those holdings in there and
then you could hedge let's say that
portion of your portfolio so it's not
always that your entire portfolio needs
to be hedged so here's another
interesting choice which is actually in
line with the same example of hedging a
specific sector but in this case what if
we were to put on a hedge on what we
think would most likely struggle in the
event of a market pullback so what what
stocks look the most overpriced if you
go back to the tech bubble well it would
have been tech stocks if you go back to
the 2008 crash well it would have been
banks that crashed the hardest if you go
back to the old crash that happened in
2015
oil stocks would have crashed the
hardest so in theory if we could
identify which companies are running
sky-high right now and if the market
were to break hypothetically
those would break the hardest and if you
happen to have a well-placed put option
or two or three or five or ten on the
companies that are most likely to break
well you could make a fortune if they
did in fact fall the hardest so my
question to you is are you currently
hedged are you currently worried about a
market crash and if you are hedged
how are you hedged do you like the
hedges that we talked about here would
you do it differently let me know what
you think in the comments below and if
you made it this far in the video I
really do appreciate you sticking with
me all the way to the end and don't
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and I'll see in the next video