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Ep 76: Hedging a Portfolio in Trouble and Killing Your Risk!

March 17th, 2016

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Hey this is Sasha Evdakov and welcome to another episode of let’s talk stocks; it is episode number 76 and in this episode we’re going to be discussing hedging a portfolio in trouble or preparing for a fast market move.

I’ve already actually shot this video, and unfortunately we had a video crash so I had to record it, so here what I want to do is, right around 3 o’clock in the afternoon, March 17th 2016, I’m going to go ahead and re-film this video and give you some insight.

Some of these positions that we’ll be talking about are actually just some of the things that I’ve actually just done. So here we are in a simulated trading panel and platform, with fake money, not real money that I’m going to share some insight with you about hedging, and understanding how to hedge, what is hedging, why you may want to hedge and so forth.

Let’s get started

To get the discussion started, let’s go ahead and first look at a general portfolio. And if we were to do that, let’s go ahead and purchase some shares, again, fake shares, fake money.

We’ll go ahead and purchase some shares, let’s say 100 shares of Caterpillar right here, so we went ahead, we got filled in that, and we’ll go ahead and get some shares of Wal-Mart. We’ll go ahead and get 100 shares of Wal-Mart as well.


We’re filled in both of those, and now you can see we have 100 shares of caterpillar, 100 shares of Wal-Mart, and we’re actually already up $10, which, things move pretty quick in the market. But if you look at this over all, as a portfolio beta waited, and I’ll go ahead and just hide the simulations.

You can see that right here on a portfolio beta waited, you can see that right here, as these stocks move up, this is my portfolio.


This typically is used a lot in option trading portfolio. And with option trading there’s a lot of time expiration, which I’ve done here in episode 75, but my goal for you here to discuss some hedging is really to see how far advanced we can get in these lessons.

Learn how to manage your portfolio

With hedging, it’s all about learning how to manage your portfolio. This profit and loss graph that we’re looking at right here, this is just a picture that shows your positions.

And if you start understanding these positions and know what is happening to your portfolio, you’re able to better make changes and adjustments when a black swan event happens. When something unexpectedly happens, or if you expect the market to sell off.

I’ve put these positions in a more positive direction, because that’s how a portfolio is typically structured, we look for stock appreciation. But of course you could have shorting positions in here and all kinds of other positions. Don’t let that confuse you; you could do this exact same thing to the negative side as well.

Here in this example we have a few basic positions on, and if we go ahead and just look at the portfolio beta waited on caterpillar, you can see that right here we have a delta of 100, what does that mean? It means that for every dollar move that stock head higher, we make $100, because we have 100 shares.


If we look at Wal-Mart, it has an 11 delta, but that is because we’re caterpillar waited. We are beta waited between the caterpillar. But if we go to Wal-Mart, you can see that our delta is still 100, because we have 100 shares of stocks. So for every dollar move in that stock, in Wal-Mart, we make $100.

If we beta wait them together, and we put in the caterpillar, you can see that there’s changes of delta, and it appears like it’s a larger delta. And if I go to caterpillar, you can see it’s only one eleven, so it will shift your position.

If I go ahead and add another position, let’s just say Hog, and we’ll go ahead and let’s just say we buy 200 shares of Hog, and here we’ll go ahead and get filled. Now you can see that with hog, it actually again, adjusts our position and continues to add to our delta, so we had 111, and now we go ahead and add that position and then add it about 70 delta to our position.


Typical portfolio structure

Looking at this, this is how a typical portfolio is structured, and when you look at a portfolio like this, you slowly start to understand and become aware that all these portfolios, they have risk to the downside.

If you’re hedging yourself, and protecting yourself on down side, that’s great. There are a few ways to do that. So for example, right now as the market pops higher, we have a caterpillar popping higher.


If we look at Wal-Mart, it’s kind of pulling back a little bit.


If we have HOG, you can see it’s popping a little bit higher.

What is hedging?

If you’re looking at the market and you see that this market, you’re getting into a point where this market could pull back, but you have your positions already in place and you don’t want to lose them, there are a few ways to hedge.

What’s the point of hedging? The point of hedging is to minimize your risk or loses on all of your money. It’s not about minimizing losses in any individual position. It’s about minimizing loses over all.

It’s about looking at what money you have in your account or in your bank and those are the loses that you try to minimize.

Using the GLD to hedge

What a lot of people do is they try to hedge by using something like the GLD.

For example, if you buy gold, they hope that gold in theory doesn’t move exactly one to one with the stock market, so something that doesn’t move exactly with the stock market is a good hedge. Whether you’re buying silver, whether you’re buying gold.


Typically if the market pops higher in general, and not always decays, but let’s say 70% of the time the gold will do something opposite, or 40% of the time. I don’t know what the statistic is, because it’s going to change from market conditions to market conditions.

Gold doesn’t move exactly the same way the market does, so what you could do is buy some shares of this GLD.

What is it that you do, and how many shares can you do? If you go to the GLD, and let’s say I have 100 shares here, 200 shares there, 100 shares there.

If you wanted a fairly good hedge, what you could do is put on about 100 shares. Because that would give you even. If you want a slight shift, just a little hedge, you would go ahead and buy just 50 shares.


If all your other positions are, let’s say 100, 200, your gold position is only 50, that allows you to hedge just a little bit, just a little hedge, because that way if the market tanks, you’ll probably get a pop in gold, so that way, just like in all of these positions, two of them right now are positive. The other two are pretty much negative or at zero.


Diversification is the key

Basically since we just put these on, they’re going to be shifting, but you can see that half are probably winning, and then half are losing. So what we want when we talk about hedging, is kind of diversification.

You’re getting a different kind of stock that moves a little bit opposite to the market, but you still hope that it goes higher, unfortunately most of the time, if you have your stocks, like a caterpillar, hog and Wal-Mart moving higher, gold will probably move lower, in general, not always the case.

On the flip side, if you have them moving lower, at least you have this gold position that will be moving probably higher, to offset that risk. So this is considered a hedge, this is considered one way to hedge a portfolio or position.

Hedging on a different time frame

Another way to hedge, and this is where I wanted to get to, was that you could simply hedge on a different time frame.

Like right now we’re looking at an overall global portfolio hedge. We have it on our portfolio, and when we sell caterpillar, hog and walmart, if we do it all in one day, we also get rid of gold, because we get in all our portfolio positions all at once, then we get out of all of them at once.

The other thing that you could do is look at a time frame dimensional difference, in terms of how long you hedge for.

If you see something happening in the markets, if you see something coming up, and let’s say you come up into a large, major sell off.

If we’re looking at the S&P, you slowly start seeing this market roll over and you might see a tick, like this volume bar here on January 4th. Maybe you see prices that may continue rolling over, and it starts breaking that moving average. And you say, well, I’m a little worried for the next few days, what is it that I could do?


What you could do is hedge based on the market. So there’s a few different equities that you could do this with. You could do it with the QQQs, which is a pretty good way to hedge. You can do it with the SPY. You could even do with the diamonds, the diamonds also are just the Dow Jones ETF. So there’s a few ways that you could hedge.


What you could do is, if you see a problem coming into the markets, rather than getting rid of your positions, because if you’re worried about your positions, but you don’t want to make these adjustments, let’s just say you have a lot of adjustment or a lot of positions on.

Let’s put on a few positions. Let’s go ahead and get, let’s say 50 shares of city group. And then let’s go get some more shares of sprint, Let’s get 100 shares of that. And let’s see what other one. How about Visa, go ahead let’s say we got 50 shares of visa. It’ll start maxing us out over here on our portfolio.


Let’s say we have a lager portfolio. Right here we have a few stocks, which really after 5, unless you’re trading more than a million dollars, you don’t need to be trading more than five stocks, because the management behind it gets tough.

Hedging when a problem shows up

Here’s where the issue comes about, when you have three to five positions, and if you start seeing a black swam, a war, Ebola, a problem coming into the market. Here’s where the issue starts to become kind of a problem, where you need to do something but to change every one of these is a lot of work.

Not a lot of work to just execute the order, but there’s transaction fees, not to mention you don’t know if you’re going to get perfect pricing or great pricing, so you’re still good on these to hold all these stocks for the long term. Long term meaning, let’s say five months, six months, two years, five years, whatever your long term view is.

But you’re still worried about something happening. So what is it that you could do? Well, you hedge, and you hedge it one way.

We’ve already talked about this gold, but what you can do is, I’m going to go ahead and stack this position a little heavy, we can go into the spiders, or even the QQQs and what you do is, you can short it. So you short it, let’s say 500 shares.

I’ll short it right there, and now I’m shorting it in a fairly large way, right here the QQQs, I’m putting in, if you’re looking at the buying power on these, most of these are 1000 – 3000, but then I’m shorting this for 500 shares. And I may only hold this for three days, two days, five days, seven days, so you’re shorting it because what you see is, you see all these other positions losing money in the market starts crashing.


When the market starts crashing, if you short, let’s say an index, like the QQQ, like the SPY, you’re starting to see a command right here $40, whereas some of the other positions that we have aren’t moving, but you see what happens is that this one positions, because it’s a larger hedge right there, you may just hold it for one day or two days, it allows you to recoup some of these losses.

Some of the loses that you’re going to incur in these stocks will come in because the market sells off, but you’re not going to lose in terms of total account value, you won’t lose a lot of money because you have this hedge on the QQQs, because you have this to offset those loses.

That way at least you’re still in the positions. Because you have to look at it from a bigger picture stand point. What is your portfolio doing? And of course you could get rid of all these positions and then later get back in again, but how do you time that perfectly?

It’s quite difficult to time and get in at the lowest possible price, and get out at the highest possible price.

It’s very difficult to do that, so if you can get a hedge like this one, which is actually turning into a really great example right now, you can see that this is bringing in our profits, $70 worth of profit right now on this hedge.


And if these other things were crashing right now, at least this hedge right here would be profitable, because the Qs are pulling back. So that’s what you do and that’s how you make an adjustment. So what is it it’ll do to my curve?

You can see, between all of these curves, I’m actually positioned -237 deltas to the down side, so for every one dollar move waited based on the cat, If I go to the QQQs, it’s -246 delta.


Don’t hold hedges for too long

It’s -246 delta, so for every dollar move down, we make 246 deltas, if it actually moves up, we lose 246 deltas, so you don’t want to hold this for the longest time ever. You don’t want to hold it forever, this is not a long term trade, this is a hedge, it’s a temporary position to reduce your risk and minimize your loses. It’s a hedge, it’s temporary, it’s like holding dead fish, you hold it for a little bit until it smells, and then you get rid of it.

The same thing here, if I didn’t have the Qs, I would be positioned to the upside, I’m looking for a bullish bet. But if war strikes, nuclear missiles launch from some other country, whatever it is, something happens, boom, you put on a hedge, you maybe hold it for one or two days, and that’s it, you let it ride, you collect some profits, or even you just held it, even if it was a $10 move and you didn’t make money from it, at least you’re protected.

You could’ve hedge just a little bit, so you look right here, we’ve hedge 500 shares, -500, so that way we’re making money on the down side, because that way if our stock is tanked.

The other way to hedge, and I’m going to show you what this could do, is if we analyze the closing trade, let me see if we throw up, or if we show some of these simulated trades, maybe you’ll get an idea here.

Here we have the GLD, we don’t need the Russel, we don’t need the SPY, we don’t need the SPX, so here, if we go ahead and we have this short on the QQQs, right now we’re short right here, and this is what the chart looks lie, but if I went ahead and I wanted a little more balance, because without that, we would’ve been positioned to the upside, we would’ve been positioned positive, so we would hedge with the Qs.


Now we’re positioned to the downside. But if I position it only with 300 shares, you can see my profit lose curve starts to even out, my deltas are fairly neutral.


Really I could’ve done, let’s see, let’s go to 250. You could play with this, but let’s say 240, right here, so now I flatten my curve to a 15 cent delta.


And of course this is relative to a beta waited on the QQQ, but if I’m really worried, I could kill my deltas, which right now they’re 260 without the Q.


But if I go ahead and put on those appropriate positions to kill the deltas, now if these things move up or down, I’m not making any money. Because I’m at a stand still relative to the delta.

Of course, each one of these individual positions could pop higher or pop lower, you never know, but relative, since the QQQs are a general market, let’s say it’s a large index, it’s pretty good, more tech heavy though.

But you’re tilling off your risks, so now, if relative to these QQQs, you have a beta waited position, your portfolio is pretty much neutral, you pretty much killed your portfolio, and you’re waiting for things to come down, and then what you do is you get out of those, and you’re out, and now you’re back to your position to the upside.

Because what’s going to happen is, right now I’m at a -500 shares. If I add 240 to that, I would’ve been at -300 or so. Let’s see -260, so I would’ve been really -260. Let’s take a look at how that looks.


You can see I’m at -260 on this position. So now, if I added that in, my delta really is 15 cents, and I can go out right here, and you can see the slope of this curve is very minimal, I wouldn’t really make a lot of money.

If the Qs went up to 700 over here maybe, but it’s already at 100, it would have to 7 times that value, and I wouldn’t really make much. So it’s hedging my portfolio for an event that could be catastrophic. If we sell off, I would lose maybe a couple dollars.

That’s what a hedge would do, because I’m short these positions, but I’m long my caterpillar, my gold, my hog, I’m long my sprint, I’m long my Verizon and Wal-Mart.


To withstand the storm, kill your deltas

You’re hedging with an index to kill your deltas, to kill your upside move by shorting the QQQs, which allows you to withstand the storm. It allows you to minimize the risk of a catastrophic event, an election, whatever it is. It doesn’t matter. But it’s something global, something large in terms of risk.

So if something happens, you kill your deltas by going into an index fund and that’s hedging your portfolio, which allows you to sustain a storm.

Whether that’s Ebola, terrorism, whatever it is, fear, the Greek, the British pound collapses. Whatever it is, it doesn’t matter, but this is how you do it. That’s how you can hedge, it’s you can go ahead into an index like this, like the QQQ and go for it and go for it by shorting the stock.

There’s also the inverse of this. If you go into the inverse of this, like the SDS, which is the pro shares Ultra Short S&P, I don’t typically like trading these as much, because most people don’t understand how they move, function and react, but this is the short S&P, so you would simply buy this, because you’re shorting it already, you would buy it and this would pop.


Because remember, this is based on shorting. So if the stock market goes down, this goes up. So it works as an inverse, it’s like an inverse ETF in a way. And if you search for inverse, I believe you can see right here, they have inverse VIX, They have three times inverse gold.


They have all kinds of inverse ETF, but any time you see this three times inverse ETF, those become really dangerous, because you’re leveraging, and if you don’t know what you’re doing, I highly recommend you stay away, but there are ways you could just do this SDS, something like this, and just buy that as a hedge or short, and the this would pop, if you have, whatever, terrorism, Ebola, some kind of scare, because the market would sell off.

Hold it just for a few days

That’s another way to look at it. But here I’m just hedging it by shorting the QQQs. When I’m done, let’s say I’m holding it for just two or three days, I would buy back these to close out my positions. Because I don’t’ want these positions to be negative any ways. I don’t want to lose money on that position, because without all of these, if I uncheck all of these, I’m actually short the market without all these other positions.


I don’t want to hold on to this forever, that could be just a two day move. So keep that in mind, it’s simply like a two, three day move that you might hold this. It could be a 7 day. Depending on how big the problem is, you might hold it for 7 days, 12 days, 15 days, if you’re in a bunker, you can hold it for 20 days, and that could be a potential, if you’re in a bear market, you’re going to hold it for half a year.

And then let it ride and capitalize your profits and buy more stock if you want. That’s up to you. But the point being here is that you’re holding it for a smaller time frame than what you plan to hold your stocks to hedge from catastrophic events, and that’s what a hedge does, it minimizes your whole portfolio risk.

It doesn’t minimize your risk on the positions; it minimizes your risk on the money and the capital that you have on it. So when you need it, you go ahead and you use it. But once you have your positions on, and you have these positions cooking, and if you’re on with a short position like this to hedge, and you’re ready and the market appears to be heading higher, you go ahead and you buy it back, close out that position, now you’re ready to cook again to the upside. So that’s what you do.

Gain back some of what you lose

Of course, your other positions would be starting at a negative, because they would’ve probably sold off. But you would’ve profit it whatever the amount was from this run to the down side, from the QQQs, so you would’ve bought them back at a profit. And even though you might have lost $3000 on those positions, you might have at least gain back $2000 for shorting these QQQs, and now at least you only loss over all $1000 from the hedge. And of course if your hedge is larger, you could’ve actually made money, because you would’ve positioned it more to the down side.

For example, if you positioned it more like this to the downside, and you hedge even more, with more shares, the you could’ve been profitable, and then flipped on a dime and bought the shares back when you were ready to go back to the upside.


That’s really what hedging is on a simplistic level, that’s one of the ways to do it, that’s one of the ways I like teaching it, to really explain the basic concept. I really didn’t want to go into too much detail about other ways of hedging at the moment, but I wanted to see and test the limits of where you personally are with the market, with the videos.

I don’t believe, and I don’t know, I don’t watch the videos on YouTube relative to the market education, typically I prefer to read books or attend a seminar, and just it allows me to digest things in my own way, but I remember that watching videos was really helpful for me.

When I was watching the videos, I don’t remember anything like this being shown or taught, so hopefully this was helpful, but I know that when talking about these topic, these are a little more advanced topics, and the last two episodes, such as episode 75 and now episode 76, I really dabbled with kind of intermediate to advanced topics, so I’m kind of tasting the waters to see where people are and where people get confused or not.

A lot of times I will leave more detailed concepts within my courses, but I wanted to see how people digest this information, so if you personally are getting this, fantastic and it’s helpful, great, let me know.

If you’re a beginner, go back to the fundamentals

If you’re not and you’re struggling, just feel free to ask a question there in the comments or the feedback, and I’ll try to go into a little more detail into some of these subjects, but I don’t want to over do it, because if you’re just brand new, if you’re just starting out, and you’re seeing this episode as your first episode, or you’re listening to this, and this is the first episode that you’re hearing from me, you might be wise to go back and review some of the past material, because this is already starting to get into some more complicated topics about hedging, and about tweaking your positions and you really need to understand the key fundamental concepts before your grasp and jump to the next level.

The flow channel

And sometimes when you share very complex thoughts, or complicated ideas, where the skill level doesn’t meet your experience, then there really becomes anxiety and a problem.

Actually let me pull up a chart of this, so this is called the flow channel, right here that I’m looking at.


And this flow channel is basically where you want to be when you’re learning, studying, putting on trades, this would be a good topic to talk about next time, but basically on one axis on the left, top to bottom, you have the challenge level, and on the bottom axis, left to right, you have the skills channel, or the skills axis, and this is from the flow, a book by Mihaly csikszentmihalyi

I guess that’s a polish name, I read the book, it’s a great book, but a lot of it talks about the flow.

Skillset vs. Challenge

In either case, if you have a high degree of challenge, and you don’t have the skillset, you’re at a low skills set, you would be put in to the anxiety level. Or pretty much you’re not going to fulfill your challenge, because you don’t have the skills, and your challenge is extremely difficult.

So if we’re going into too much detail right now on these trades on hedging, and you’re not understanding it, it’s way beyond your skill level, then you need to go back and do more studying.

On the other hand, if your skill level is extremely high and what we’re discussing is really easy, the challenge level is low, you’re going to be bored.

The best approach is really where your skillset and challenge meet kind of at the same level, and when they’re balanced, when you have that balance, you’re in that flow channel, and that’s where you want to be and where you want to get to.

And that’s what I wanted to do in this information, is just share with you some concepts, maybe a little bit more challenging than some of the other videos I have been discussing in the past, but I know that there are some viewers out there, specially some of the people that have read the books that I share, that have studied the material, the courses that I share, and have really gone into detail with it. They need a little bit more, they want a little bit more, they’re hungry for it.

If this was a little over your head, go back, review some of the past episodes, continue to study price, action, volume, behavior, how things move, how stocks react, get to that, and then come back to these lessons.

It’s like playing chess

But hopefully this gave you some insight into hedging, into a little bit further level. And you can continue to evolve. It’s all about just learning how to manipulate things within the market of manipulating your positions for risk and money management, and this is how it works. It’s kind of like a chess set, where you get all these chess pieces, but you’re the one that gets to move the knight, the pawns, the rook, you get to move the pieces the way you want to. There’s no specific formula, there’s no secret sauce. It’s all about you deciding what the risk is, and making those changes.

I hope this was helpful, take the lessons, absorb it, soak it up, digest it, there’s definitely more ways to hedge, adjust, manipulate your positions, but I just wanted to get the ball rolling and started on this and share some insights and share some wisdom with you s that way you could convert it, transform it and make it your own.

Next week we’ll probably do something a little bit more simple, in terms of lessons, but for now just take this, absorb it, soak it in, continue to study and I hope you make it your own and just adjust it to what is it that you need.

But you’re always looking at your risk, and that’s what hedging allows you to do, is watch the risk, manage the positions and tweak it if necessary, and there are, of course, multiple levels behind hedging, it just takes time to get there, and you’ll slowly start being aware of those, the more trading you do, because you’ll start to make it your own.

Author: Sasha Evdakov

Sasha is the creator of the Tradersfly and Rise2Learn. He focuses on high-level education speaking at events, writing books, and publishing video courses on business development, internet marketing, finance, and personal growth.

I'm Sasha, an educational entrepreneur and a stock trader. In addition to running my own online businesses, I also enjoy trading stocks and helping the individual investor understand the stock market. Let me share with you some techniques & concepts that I used over the last 10+ years to give you that edge in the market. Learn More

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