Harnessing Hedging Techniques to Secure Your Portfolio in Uncertain Times

Discover the strategic moves to protect your investment portfolio with the insights of Steve Davenport, as we tackle the complexities of hedging in turbulent times. Amidst the cacophony of global conflicts and whispers of recession, this episode of Skeptics Guide to Investing becomes your beacon of clarity. Join us, as we reveal why liquidating assets isn't the only answer for investors bracing for a storm, especially those with taxable assets or those eyeing retirement without relinquishing hard-earned gains.

Embark on a journey through the market's ebb and flow with us as we break down the use of put and call options—your financial 'umbrella' against unexpected downpours. While options may not be the go-to for every investor, understanding their purpose can be pivotal in times of market volatility. Steve's insights demystify market multiples, interest rates, and the economic indicators that might sway your hedging strategies. 

Straight Talk for All - Nonsense for None


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Transcript

Clem Miller: 0:26

Welcome everyone to Skeptics Guide to Investing. I'm Klem Miller and today we're going to talk about hedging stock on overall market exposure. Steve Davenport and I will dig into the reasons for considering hedges when there can be risks on the horizon and selling is not practical.

Steve Davenport: 0:44

Steve Klem, there's a lot to think about in today's market An ongoing Ukraine conflict, expanding Middle East conflict, potential blockade in Taiwan recession talks.

Clem Miller: 0:57

Steve, don't? We always have areas of conflict around the world?

Steve Davenport: 1:02

Not really, klem. I think that your top 10 risks mention this and they all seem to have just a little bit more likelihood now. The best time to buy an umbrella is before it starts raining. These are ideas which are not for everyone. When you are retired and most of your assets are in your IRA or 401K or other non-taxable account, selling can be easy to lower your risk. What I'm discussing is for someone with taxable assets that may be close to retirement. These individuals may have large gains and they want to continue growing the assets. Another example might be people with a large Nvidia position.

Clem Miller: 1:40

Well, okay, Steve. So how do we hedge some of these assets?

Steve Davenport: 1:44

Here are the basics. These are my thoughts and not advice, just education. You use something called a put option and a call option. A put option gives you the ability to sell a stock at a certain price for a certain time. A call option gives you the ability to buy or call the shares for a particular time and at a price With the market at about 500 on the SPY or 5000 on the SP index. Think about a six to nine month period. You may want to include the election 10 to 15%, down at 425 to 450. These are parameters that you can change.

Clem Miller: 2:27

So, steve, these are short-term periods. Are we really skipping the long-term part of investing?

Steve Davenport: 2:34

Most individuals don't need options, but it is wise to understand they're available. Here are some numbers to think about market multiples of 23 to 24 times versus an average of 18. Higher rates for longer will make banks and commercial real estate suffer. Upchecks in car and credit to link with Cs, Inverted yield curve is still in place and the US military is stretched with multiple areas of conflict. Do you ever think about hedges?

Clem Miller: 3:05

Okay, so I like buying high quality names and I like to hold them for a long time. To me, I think, over the long run, the market works out. So no, I don't really think about options, but certainly there are a lot of people out there who could benefit from them.

Steve Davenport: 3:24

Yeah, I would agree with you and say that these are not for the typical investors. How do you think about individuals? How do you think individuals should think about hedging? 21% is on the lower side of historic numbers. The S&P September 425 options, the SPY, are at about 0.85% and the 450, which are closer to 10% down, are about 1.3%.

Clem Miller: 3:58

Steve, let me ask you about those numbers. Can you tell me what those numbers refer to when you talk about September 425 and 0.85% and so on? Our average investor may not be familiar with those numbers.

Steve Davenport: 4:14

When you think about the strike price, that's the price that you can sell. If you own the SPY or another index one, you would buy the option, the put option, at 425 and by buying that put option you gain the ability to sell from now until September. So if there is a decline, the price of that option will go up. You're paying about. If you have a million dollars, you're paying about 0.85, which is about $8,500. And if you want to get closer, at 450, which is 10% down. We're up over 20% year to date on a lot of things in the market. So I think that it's not a bad thing to consider.

Clem Miller: 5:05

Okay, so obviously these are complex kinds of financial instruments and of course, there's many different ways to accumulate concentrated positions, For example, those who accumulate individual stocks through their work or inherent hot stocks over time. Here's how I look at larger names or exposures in my portfolio. I do have some concentrated positions, but a few concentrated positions, but overall in my portfolio I hold about 50 stocks, so I would say that I really am fairly diversified.

Steve Davenport: 5:50

Sure, I know this is a first world problem to have too much stock. I think everyone should talk to a tax or investment advisor about what is too much. My point is there can be times to step back and reevaluate. Considering an idea and how you feel about a 20% decline is healthy, just like a little skepticism.

Clem Miller: 6:14

Steve, I'm shocked. Shocked that you're bringing up skepticism again. Should we just carry on and not talk about 20% to 30% declines? Silence is golden.

Steve Davenport: 6:25

I'm not sure what silence is the answer Clem, whether we talk about declines, recessions, personal finance or human rights.

Clem Miller: 6:36

Well, I think that is. I think those situations, all of those things that you mentioned, need to be considered, but I think we need to be careful about our money, and I know that you're thinking about options as a way to be careful, and I'm thinking more about the long run and not missing out on upside.

Steve Davenport: 7:03

Sure, there's inflation, there's long run. There's a lot of things to think about, and I'm not saying this is ever going to be the answer all the time, but I think that if you have trouble sleeping at night, if you're not sure about your investments, if you feel like you have to be in something because you need to make up for lost time in the market because you started late, there could be reasons that you'd want to do something. So I believe that nobody cares about your assets as much as you do. So you need to know what your options are. Ha ha.

Clem Miller: 7:41

So I mean, really, what we're talking about here is the difference between asset preservation and asset accumulation, and those who are interested in asset preservation probably can benefit a lot from options. Do I have that right? Yeah, I think so.

Steve Davenport: 7:59

I mean, I think that we're in a period where there's a higher feeling of risk. Some people can look past that feeling and put it in its place. Other people have trouble with that and my point is markets are not the same for everyone. They're experience level, their family situation and their own economics. So I think it's really a question about behavior and I welcome the discussion because I think behavioral is really an area that we start to talk about, as well as fundamentals and quantitative reasons. There's a quote a recession is when your neighbor loses his job. A depression is when you do. Risk is not beating of a benchmark or losing purchasing power, risk of losing income or of losing the value of the asset. One defines the risk differently.

Clem Miller: 8:55

So, steve, my investing, my experience with investing is really one of trying to accumulate assets, and I feel like I'm doing a pretty good job with my personal investment portfolio. I'm pretty happy with what I've been able to do, but I think that I'm in a different position than a lot of people, because I follow individual stocks very closely and I follow markets very closely, and I know a large part of our audience doesn't do that, and so maybe they'll benefit from having options. Yes, klamat.

Steve Davenport: 9:40

Hedging is not for everyone. That is a summary of what I think you should kind of think of how to put it in perspective. Understand your needs for the next six to 12 months. Do you have a large purchase of something that you're going to need cash for? Therefore, you need to immunize that cash and make it put it on hand by selling. Consider your wants for the same period.

Steve Davenport: 10:02

If you want to change and sell your house and buy a new house, or you want a beach house, or you want a new car and you've got money aside, maybe you want to put it in a store or a safer vehicle instead of in equities on the market. Are you nervous or not sleeping? Well, this can really become a regular event where you start to hear the news which is overwhelmingly negative, and it can make your life a little bit more difficult. There are ways to get around that, and this is one of them Diversify in no or low-tact risky assets first. If you've got a taxable account that's got a lot of risk in it, take a little bit off. Diversify Then. I think it's learning about hedging that's important, not the fact that you do hedge. I think it's another tool, do you?

Steve Davenport: 10:55

have anything else to add, Clint.

Clem Miller: 10:57

I would just add that I think you'll keep learning a lot if you listen to Steve's in my podcast. I think that'll add to your financial knowledge over time and you'll be more educated as to these different options, so to speak. It'll help you with your ability to make money or to preserve money.

Steve Davenport: 11:25

Steve, that's good. Thanks for listening everybody. Thanks everybody.