Introduction to Hedging: Protection in Uncertain …...Technical indicators are giving bearish...

11

Introduction to Hedging: Protection in Uncertain Times

Fidelity Brokerage Services, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917. © 2016 FMR LLC. All rights reserved. 708601.4.0

22

Disclosures Options’ trading entails significant risk and is not appropriate for all investors. Certain complex options

strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options, and call 800-544- 5115 to be approved for options trading. Supporting documentation for any claims, if applicable, will be furnished upon request.

Examples in this presentation do not include transaction costs (commissions, margin interest, fees) or tax implications, but they should be considered prior to entering into any transactions.

There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, and collars, as compared with a single option trade.

The information in this presentation, including examples using actual securities and price data, is strictly for illustrative and educational purposes only and should not be construed as an endorsement or recommendation.

Trailing Stop orders are monitored between 9:30 AM and 4:00 PM Eastern Standard Time and are maintained on a separate order file on a “not held” basis until triggered, at which time they are sent to the marketplace. Additional information about Trailing Stop orders is available at Fidelity.com (link: https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/Conditional_Orders.pdf)

ATP: Active Trader Pro PlatformsSM is available to customers trading 36 times or more in a rolling 12-month period.

P/L Calc: Profit probability shows how likely a particular option trade (or combination of trades) will be profitable, based on a calculation that takes into account the price of the trade and the expected distribution of stock prices based on the 90-day historical volatility.

33

Goals of Today’s Presentation

Help grasp the general concept of hedging and the different methods that could be used

What we will cover:– What is hedging and why do trader’s do it– Stop, Trailing Stop, and Conditional orders– Protective Puts– Beta… what is it?– Collars

44

Whatishedging? Protectingasecurityand/oraportfoliotominimizetheimpactofanadversemove.

Whydotrader’shedge? Concernwithrecentvolatility,butstillbullish

Overallmarketorsectorweakness

Shiftinfundamentalinformationthatcausedyousomeconcern

Technicalanalysisisprovidingpossiblebearishsignals

Taxsituationisnotfavorabletoliquidateatthispoint

Trader’sView:Hedgingisnotthesameasspeculation.Hedgingisusedtoprotectfrom,notprofitfrom,anadversepricemove.

IntroductiontoHedging

55

Dormantmarketorderuntiltriggeredbylasttradeatorbelowthedefinedprice(viewedbythemarket)

Dormantlimitorderuntiltriggeredbylasttradeatorbelowthedefinedprice(viewedbythemarket)

Movingdormantmarketorderwherethetrigger/stopisdefinedbypercentageorspecificamountfromthedefinedtrigger(last,bid,ask)(inhouse)

Movingdormantlimitorderwherethetrigger/stopisdefinedbyapercentageorspecificamountfromthedefinedtrigger(last,bid,ask)(inhouse)

Theseorderscanalsobeused,andtriggeredbasedonanynumberofcriteria

Trader’sView: Pricealertscanbesetupasanalternativetousingastoporder

OrderTypesUsedtoManageEquityPositions

Stoploss

Stoplimit

Trailingstoploss

Trailingstoplimit

Conditionalorders

‐Triggerpricespertaintoequities

66

Securitygappingcouldcauseamuchdifferentresultthanwhatwasexpectedfromthestoporder.

EnemyofStopOrders:GappingRisk

*Active Trader Pro – For Illustrative Purposes Only

77

Advantages: Lowcost(commission) Automaticallyclosestheposition Disciplinedtradingprocessreducesemotionaldecisions Attachesprice,orpercentage,todefinelossthreshold Exitpositionwhenimportantsupport/resistancelevelbreachedDisadvantages: Gappingrisk(forstoporders) Orderneverexecutingbecausethesecurity

continuestomove(stoplimits) Liquidateatunfavorabletime(taxsituation,

triggertooclose)

StopandTrailingStopLoss/Limitbreakdown


88

Ahedgecanbeanythingthatgainsvalueasthepositionyouareconcernedaboutislosingvalue.

Atruehedgedefinesthepotentiallossonalongposition. Themoreseparationbetweenthepositionofconcernanditshedge,thelesseffective

thehedgewillbe

Therearemanypopularwaystohedge:

1. Usingputcontractsonindividualpositions2. Usingputsonanindexasaproxyforaportfolioorsubsetofaportfolio3. Goinglongsecuritiesthathaveahistoryofmovingintheinversedirectionofthe

position

WaystoHedge

99

Premiumisspenttopayforprotectiononsecurityorindex,putsincreaseinvaluewhenunderlyingdecreasesinvalue

Trader’sView:Hedgebeginsatbreakevenofputs(Strike– Premiumpaid).Rememberyoupaidapremiumtohavethehedge.

Advantages: Actsasatruehedge Thecontractholdercontrolsif/whenthecontractisexercised Allowmoreflexibilityformanagingindividualtaxsituations Nogappingriskwhilethehedgeison

Disadvantages: Costtoestablishandmanage– Increasesbreakevenontheposition Oftencostsmorewhenthetrue“need”arises Timetomanage Requiresanunderstandingofamorecomplexfinancialinstrument

BuyingPutstoProtectPosition/Portfolio

10

Assumeentry@$92.76on4/17/14

Hedgeestablishedwhileunderlyingis@$96.63on7/31/14

UsingJan2015$95Puts@$3.95

Supportidentifiedaround$94.00



1111

BuyingATMprotectiveputsdefinesthelossontheposition

Maxlosstothedownsideisnowlimitedto$174.00

Breakevenincreasesto$96.71

from$92.76

Unlimitedprofitpotentialremains


Trader’sView:Makesuretoprovideappropriateduration.Remembertheclosertoexpiration,thehigherthetimedecaywitheachpassingday.


1212

HedgedPosition:

LossLimitedto$174

UnhedgedPosition:

Lossof$13.13/share=$1313totalloss

Entry@$92.76on4/17/14

Currentprice$79.63



1313

Forlargerportfolios,sometrader’swilluseputsonanindex orETF asahedge MostcommonindexorETFtohedgeportfoliosistheS&P500(SPY,IVV)– otherindicesmaybemore

appropriatedependingontheportfolio Notexact,riskoftrackingerror

Buyingputsforeachindividualpositionsprovidesthemosteffectivehedge,butisusuallymoreexpensiveandrequiresmoretimetomanage

Tocalculatethe#ofcontractsneeded,takethecurrentvalueoftargetassettohedgedividedbytotalmarketvaluethattheputscover(usuallyStrikePrice*100)

Forexample:Atthetimeofthiswriting,theS&P500wasat2050.EachATMcontractcovers$205,000(2050*100).Acloselycorrelated$1,000,000equityportfoliocouldbehedgedwith5putsontheindex.

Trader’sView:IfusingindexorETFputcontracts,considerthedifferencesinexercisestyleanddeliverableonthecontracts


1414

Measuresthesensitivityofpricechangeofanunderlyingcomparedtoabenchmark ABetaof1.00meanstheasset’spricesmovetogether ThemostcommonbenchmarktradersuseistheS&P500butbetaweightingcanbedone

betweenany2assets Betaisnotastaticmeasure,itisconstantlychanging

S&P 1%

Beta= 2

Security 2%

S&P 1% Security 2%

Trader’sView: Betaweightingtheportfolioallowsatradertoadjustthehedgetobecomemoreeffective,butbetaisconstantlychanging

Beta…Whatisit?

1515

Collar:BuyingaprotectiveputandreducingthecostbysellinganOTMcall Limitsupsidegain,butreducesthecostofthehedge

Trader’sView: Aputspreadcanalsobeusedtoreducethecostoftheprotectiveput,butitonlyprotectsthepositiondowntotheshortstrike

Maxlosstothedownsideisnowlimitedto$74.00– lowerthantheprotectiveputduetopremiumfromthecall

Breakevenislowerthantheprotectiveput:$95.71vs$96.71

Tradeoff:Maxgainisnowlimited

Collars


1616

StopOrders ProtectivePuts IndexPuts Collars

Cost Costofacommission

Mostcostly,individualpositionbasis

Usuallylesscostlythanbuyingonindividual

positions

Sellingthecallreducesthecostofthehedge

Upside Unlimited Unlimited Unlimited Limited

Effectiveness Doesnotserveasatruehedge

Mosteffectiveduetodirectrelationshipwith

theunderlying

Effectivenesswillvarydependingonlevelof

correlationbetweenindexandthestockportfolio

Mosteffectiveduetodirectrelationshipwith

theunderlying

EaseofManagement

Dependentonthenumberof

positions– mayrequiresignificantorlittleeffort

Mayrequiresignificanttimeandeffortto

manage

Generallyrequirestheleasttimeandeffortto

manage

Mayrequiresignificanttimeandeffortto

manage


1717

Hedgingisdonetominimizetheimpactofanadversemove: Shorttermvolatilityexperiencedwithbullishoutlook Overallmarketweakness Liquidatingwouldcreateunfavorabletaxsituation Shiftinfundamentals Technicalindicatorsaregivingbearishsentimentbutlongtermoutlookbullish

Stopandtrailingstoporderscanhelpmanageriskforthecostofacommission,butdonotserveasatruehedge

Protectiveputsserveasaneffectivehedge,butatthecostofthepremium

Thestrongertherelationshipbetweenthehedge,andtheassetitisintendedtoprotect,themoreeffectivethehedgewillbe

Collarsallowsformorecosteffectivehedgesatthecostofupsidepotential

KeyTakeaways

1818

Thankyouforattending.

Toregisterforupcomingwebinars, pleasevisittheFidelity.comLearningCenterhttps://www.fidelity.com/learning‐center

Foradditionalsupport,I’mhappytohavea1:1appointmentatyourconvenience.

Thisconcludestoday’spresentation.


Introduction to Hedging: Protection in Uncertain …...Technical indicators are giving bearish...

Documents

Transcript of Introduction to Hedging: Protection in Uncertain …...Technical indicators are giving bearish...