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Screen capture via Bloomberg TV
“Something’s About To Happen”
The SPDR Gold Trust ETF’s (GLD) chart was analyzed by Fidelity technician John Gagliardi on Bloomberg TV’s “What’d You Miss” program on Wednesday. You can see the full segment here, but below is the key part for GLD longs:
Abigail Doolittle: What about that MACD on the bottom, does that tell you want to get into GLD at this time?
John Gagliardi: Well, the good thing is that this MACD is positive on the weekly, and I always tell people, “when in doubt, zoom out,” and if you zoomed out, and you changed this from weekly to monthly, that MACD is flat as a pancake, right on the zero line for about five years. So something’s about to happen, we just aren’t sure what yet.
The binary uncertainty Gagliardi expresses there makes GLD a good candidate for hedging: Heads you win (if GLD does well), and tails you don’t lose much (if GLD stumbles). Let’s look at different ways you can stay long GLD while limiting your risk in the event the “something” Gagliardi alludes to above turns out to be bad.
Different Kinds Of Downside Protection For GLD
Up to now, when I’ve posted hedges for securities, I’ve used expiration dates approximately six months out. That’s been Portfolio Armor’s default for years, partly out of convenience for investors, and partly for the reason Riskalyze CEO Aaron Klein explained here: Investors seem to be better able to conceptualize risk over six-month periods than longer ones. That will still be Portfolio Armor’s default going forward, but we’re adding a new feature that will let users select their own expiration dates.
This raises an interesting question: What’s the cheaper way to hedge if you adjust for the different times to expiration? In general, shorter times to expiration mean less time value and less cost for put options you purchase to hedge. But if you are offsetting the cost of those put options by selling call options, increased time value means you can get more for the call options. To illustrate this, below are four ways of hedging GLD. Two of the hedges expire in approximately three months and two expire in approximately one year. I’ve highlighted the annual cost of each hedge, so you can compare apples to apples. Each of these hedges is designed for an investor unwilling to risk a decline of more than 10% in his GLD shares.
Uncapped Upside, ~3 Months To Expiration
These were the optimal, or least expensive, puts, as of Wednesday’s close, to hedge GLD against a >10% decline by late September of this year.
The annualized cost was 0.23% of position value (the cost of the puts in all four of these examples was calculated conservatively, using the ask price – in practice, you can often buy puts at some price between the bid and ask).
Uncapped Upside, ~12 months to Expiration
This hedge uses the same parameters as above, except the expiration date is in June of 2020.
The annualized cost is higher here, as you can see: 0.97% of position value.
Capped Upside, ~3 Months To Expiration
This was the optimal, or least expensive, collar to hedge against a >10% decline by late September, if you were willing to cap your possible upside at 20% by then. The income generated from the short calls for this collar and the next one was calculated conservatively, assuming you sold them at the bid.
As you can see here, the annualized cost of this collar was -0.06% of position value, meaning you would have collected a net credit of $20 when opening the hedge, assuming you placed both trades (buying the puts and selling the calls) at the worst ends of their respective spreads.
Uncapped Upside, ~12 Months To Expiration
This optimal collar uses the same parameters as the one above, except it expires in June of 2020.
Here, the cost was -0.2% of position value, meaning you would have collected a net credit of $260 when opening this hedge.
Wrapping Up
I gave GLD a neutral rating here because, although Portfolio Armor estimates a positive return for it over the next six months, that return is estimated to be in the mid single digits. That estimate, of course, could be wrong. In this case we don’t have Seeking Alpha Essential’s quant rating as another check, as it doesn’t cover GLD, but Seeking Alpha contributors are bullish on the ETF, on average, as you can see below.
Screen capture via Seeking Alpha
Given the low cost of hedging GLD with optimal puts, very bullish GLD longs who want to limit their risk may want to consider the optimal put hedges above.
This article focused on hedging GLD, but my Marketplace service, Bulletproof Investing, combines hedging with a security selection method that has beaten SPY by 4.24% annualized so far, as you can see in the last table here.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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