Profitability of a hedge position

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Profitability of a hedge position2017-03-03T15:27:23+00:00
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  • Frank Grossmann
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    Post count: 169

    We have a 80%-20% hedge, so the final profit of your strategies is 0.8*strategy profit+0.2*hedge profit. It is true that for 2013 the hedge would have reduced the profit, but for all other years it does not reduce the profit, at least not with the short TMV hedge.
    The year 2013 was for Treasuries like 2008 was for the stock market. For normal years and long term investments, the hedge itself should also make some profit. Now with tapering, this profit is reduced or probably even slightly negative for a some time, but profit is only half of the game when you are investing. Reducing risk has the same importance. If you can half your draw-downs, then you significantly reduce the risk and the Sharpe ratio (Return divided by risk) will increase.
    Adding a 20% short TMV hedge to the strategies when these are invested in the stock market or ZIV will only reduce the performance in 2013. If you go back more than 3 years, then it even increases performance.
    An EDV or TMF hedge is a little bit less profitable than the short TMV hedge, but it still has a positive effect on the Sharpe ratio.

    Many subscribers have margin accounts. Then you can borrow a hedge. You do not need your capital. You pay about 2% per year to borrow for example a short TMV position. Such a position will generate much more profit than the 2% borrowing cost. This way you get a free hedge. It does not cost anything to you!

    The concept of thinking only of Return/Risk is very important. Most people only look at performance. Many of them think also that therefore leveraged ETFs are better. But this is not the case because the leverage also multiplies risk.

    One other important performance contributor for the hedge is also rebalancing. To keep the 20-80 ratio, you have to rebalance from time to time. This rebalancing is very profitable because you always sell a part of the ETF which is high, and invest in the ETF which is low. This sell high buy low is the mother of all profits.

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