Sunday, May 29, 2011

Hedging the ETF Volume Leaders

David Pinsen submits:

The table below shows the costs, as of Friday's close, of hedging 19 of the 20 ETFs with the highest trading volume, against greater-than-20% declines over the next several months. The model uses the optimal puts for that. First, a reminder about why I've used 20% as a decline threshold, and what optimal puts mean in this context, plus an explanation of why there were no optimal puts for one of these ETFs.

Decline Thresholds

The idea for a 20% threshold, as I've mentioned before, comes from a comment fund manager John Hussman made in a market commentary in October 2008:

An intolerable loss, in my view, is one that requires a heroic recovery simply to break even ? a short-term loss of 20%, particularly after the market has become severely depressed, should not be at all intolerable to long-term investors because such losses are generally reversed in the first

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