We’re a week away from the 4th of July and investor sentiment remains in the extreme optimism zone. The World Cup rolls on and the U.S. is still in contention. We’re a couple of weeks from the MLB All-Star Game. Days are actually getting shorter! Summer is definitely here.
Sentiment Remains in Extreme Optimism Zone
Despite relatively high valuations, the primary cyclical trend as we go into summer remains favorable, as measured by Big Mo and the Fed. Caution is advised; the cyclical bull is aged and investor sentiment is once again in the Extreme Optimism zone. I continue to expect a sizable summer sell-off and favor hedging equity exposure and actively managing your bond exposure in a disciplined way (i.e.: Zweig Bond Model).
Consider Your Options
As discussed in this week’s Trade Signals and most of the recent weekly postings of On My Radar, due to the level of risk, I suggest hedging your equity exposure with some form of tail risk protection (severe event risk protection). For hedging, I favor a collared option approach (writing out of the money covered calls and buying out of the money put options) as a relatively inexpensive way to risk protect your long-term focused equity portfolio exposure. Also, consider buying deep out of the money put options for risk protection.
Whether you’re new to options or you’re trying to develop advanced trading strategies, there are a wealth of educational sources to access. This video, Options Trading for Beginners from E-Trade, is a good basic introduction. The big retail brokers all have trading platforms that integrate options trading and education.
To go deeper into options, try tastytrade, an online financial network with eight hours of live, original programming every week day devoted entirely to options trading strategies.
Tail Risk Hedging: Creating Robust Portfolios for Volatile Markets (McGraw-Hill, 2014) is about using a tail-hedging overlay at relatively low and finite cost so an investor may achieve three objectives:
- He can hold his investments in other skilled managers (funds, stocks or ETFs) while hedging out the common market tail risk exposure,
- he can tune up or down the market exposure according to his needs and the opportunity sets with liquid instruments and,
- he has more predictability about the distribution of returns,: that is, he could plan his investment strategy ahead of the day-to-day implementation noise.
My good friend, Christopher Geczy, Ph.D., Academic Director, Wharton Wealth Management Initiative and Adj. Associate Professor of Finance, The Wharton School adds, “This book is critical and accessible reading for fiduciaries, financial consultants and investors interested in both theoretical foundations and practical considerations for how to frame hedging downside risk in portfolios. It is a tremendous resource for any involved in asset allocation today.”
The book is about how tail risk hedging works, how it is implemented and how it can lead to higher returns with very little cost over a market cycle. It is my hope that you find it helpful. The author, Vineer Bhansali, Managing Director and Portfolio Manager at PIMCO, does an excellent job at explaining hedging and how you might implement a strategy.