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By the time most people look to hedge their investment portfolios, the time to hedge has likely passed.
The most successful hedgers anticipate difficulties before others realize anything is amiss. They tend to be sophisticated practitioners betting on a stock market decline as much as they are trying to hedge.
When it seems as if nothing can go wrong, the market basically gives away inexpensive put options to anyone willing to buy them. But when stock prices fall—or when many investors are afraid of a decline—the opposite often happens. Hedging costs increase in response to demand. It’s like trying to buy insurance when your house is on fire.
Investors should consider this at a time when Wall Street is beginning to fret that this historic bull market may soon run out of steam. Strategists at major banks, including
Bank of America,
Deutsche Bank,
and
Morgan Stanley,
have all recently warned that the stock market might finally correct.
The pullback concerns tend to cover the big headline woes, ranging from inflation, which may be more permanent than the Federal Reserve believes, to elevated valuation levels on the
S&P 500 index
and slowing economic growth caused by Covid-19.
Investors increasingly are eager to know what they should do to protect their stock gains. Guess what? The honest answer is probably nothing. By the time most people are asking about hedging, the best opportunities have likely passed.
Futures on the
Cboe Volatility Index,
or VIX, which offer a reasonable measure of how sophisticated investors view equity risk, are elevated. If the VIX futures curve could speak, it would say something like there’s no free lunch. This critical hedging indicator has already adjusted to the specter of a stock pullback.
Indeed, hedging activity in the S&P 500 has been active over the past month, with institutional investors buying hedges just in case stocks declined. Many of those…
Read More: The Stock Market Continues to Fall. How to Hedge Your Portfolio Now.