February 14, 2024 • 11 mins
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
Please check out our other podcasts:
https://skepticsguidetoinvesting.buzzsprout.com
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Clem Miller (00:02):
Welcome everyone to Skeptics Guide to Investing.
I'm Klem Miller and today we'regoing to talk about hedging
stock on overall market exposure.
Steve Davenport and I will diginto the reasons for considering
hedges when there can be riskson the horizon and selling is
not practical.
Steve Davenport (00:20):
Steve Klem, there's a lot to think about in
today's market An ongoingUkraine conflict, expanding
Middle East conflict, potentialblockade in Taiwan recession
talks.
Clem Miller (00:33):
Steve, don't?
We always have areas ofconflict around the world?
Steve Davenport (00:38):
Not really, klem.
I think that your top 10 risksmention this and they all seem
to have just a little bit morelikelihood now.
The best time to buy anumbrella is before it starts
raining.
These are ideas which are notfor everyone.
When you are retired and mostof your assets are in your IRA
or 401K or other non-taxableaccount, selling can be easy to
(01:00):
lower your risk.
What I'm discussing is forsomeone with taxable assets that
may be close to retirement.
These individuals may havelarge gains and they want to
continue growing the assets.
Another example might be peoplewith a large Nvidia position.
Clem Miller (01:16):
Well, okay, Steve.
So how do we hedge some ofthese assets?
Steve Davenport (01:20):
Here are the basics.
These are my thoughts and notadvice, just education.
You use something called a putoption and a call option.
A put option gives you theability to sell a stock at a
certain price for a certain time.
A call option gives you theability to buy or call the
shares for a particular time andat a price With the market at
(01:43):
about 500 on the SPY or 5000 onthe SP index.
Think about a six to nine monthperiod.
You may want to include theelection 10 to 15%, down at 425
to 450.
These are parameters that youcan change.
Clem Miller (02:03):
So, steve, these are short-term periods.
Are we really skipping thelong-term part of investing?
Steve Davenport (02:10):
Most individuals don't need options,
but it is wise to understandthey're available.
Here are some numbers to thinkabout market multiples of 23 to
24 times versus an average of 18.
Higher rates for longer willmake banks and commercial real
estate suffer.
Upchecks in car and credit tolink with Cs, Inverted yield
(02:31):
curve is still in place and theUS military is stretched with
multiple areas of conflict.
Do you ever think about hedges?
Clem Miller (02:41):
Okay, so I like buying high quality names and I
like to hold them for a longtime.
To me, I think, over the longrun, the market works out.
So no, I don't really thinkabout options, but certainly
there are a lot of people outthere who could benefit from
them.
Steve Davenport (03:00):
Yeah, I would agree with you and say that
these are not for the typicalinvestors.
How do you think aboutindividuals?
How do you think individualsshould think about hedging?
21% is on the lower side ofhistoric numbers.
The S&P September 425 options,the SPY, are at about 0.85% and
(03:26):
the 450, which are closer to 10%down, are about 1.3%.
Clem Miller (03:34):
Steve, let me ask you about those numbers.
Can you tell me what thosenumbers refer to when you talk
about September 425 and 0.85%and so on?
Our average investor may not befamiliar with those numbers.
Steve Davenport (03:50):
When you think about the strike price, that's
the price that you can sell.
If you own the SPY or anotherindex one, you would buy the
option, the put option, at 425and by buying that put option
you gain the ability to sellfrom now until September.
So if there is a decline, theprice of that option will go up.
(04:13):
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 dateon a lot of things in the market
(04:33):
.
So I think that it's not a badthing to consider.
Clem Miller (04:41):
Okay, so obviously these are complex kinds of
financial instruments and ofcourse, there's many different
ways to accumulate concentratedpositions, For example, those
who accumulate individual stocksthrough their work or inherent
hot stocks over time.
(05:02):
Here's how I look at largernames or exposures in my
portfolio.
I do have some concentratedpositions, but a few
concentrated positions, butoverall in my portfolio I hold
about 50 stocks, so I would saythat I really am fairly
(05:24):
diversified.
Steve Davenport (05:26):
Sure, I know this is a first world problem to
have too much stock.
I think everyone should talk toa tax or investment advisor
about what is too much.
My point is there can be timesto step back and reevaluate.
Considering an idea and how youfeel about a 20% decline is
healthy, just like a littleskepticism.
Clem Miller (05:50):
Steve, I'm shocked.
Shocked that you're bringing upskepticism again.
Should we just carry on and nottalk about 20% to 30% declines?
Silence is golden.
Steve Davenport (06:01):
I'm not sure what silence is the answer Clem,
whether we talk about declines,recessions, personal finance or
human rights.
Clem Miller (06:12):
Well, I think that is.
I think those situations, allof those things that you
mentioned, need to be considered, but I think we need to be
careful about our money, and Iknow that you're thinking about
options as a way to be careful,and I'm thinking more about the
(06:35):
long run and not missing out onupside.
Steve Davenport (06:39):
Sure, there's inflation, there's long run.
There's a lot of things tothink about, and I'm not saying
this is ever going to be theanswer all the time, but I think
that if you have troublesleeping at night, if you're not
sure about your investments, ifyou feel like you have to be in
something because you need tomake up for lost time in the
market because you started late,there could be reasons that
(07:02):
you'd want to do something.
So I believe that nobody caresabout your assets as much as you
do.
So you need to know what youroptions are.
Ha ha.
Clem Miller (07:17):
So I mean, really, what we're talking about here is
the difference between assetpreservation and asset
accumulation, and those who areinterested in asset preservation
probably can benefit a lot fromoptions.
Do I have that right?
Yeah, I think so.
Steve Davenport (07:35):
I mean, I think that we're in a period where
there's a higher feeling of risk.
Some people can look past thatfeeling and put it in its place.
Other people have trouble withthat and my point is markets are
not the same for everyone.
They're experience level, theirfamily situation and their own
economics.
So I think it's really aquestion about behavior and I
(08:00):
welcome the discussion because Ithink behavioral is really an
area that we start to talk about, as well as fundamentals and
quantitative reasons.
There's a quote a recession iswhen your neighbor loses his job
.
A depression is when you do.
Risk is not beating of abenchmark or losing purchasing
power, risk of losing income orof losing the value of the asset
(08:26):
.
One defines the riskdifferently.
Clem Miller (08:31):
So, steve, my investing, my experience with
investing is really one oftrying to accumulate assets, and
I feel like I'm doing a prettygood job with my personal
investment portfolio.
I'm pretty happy with what I'vebeen able to do, but I think
(08:54):
that I'm in a different positionthan a lot of people, because I
follow individual stocks veryclosely and I follow markets
very closely, and I know a largepart of our audience doesn't do
that, and so maybe they'llbenefit from having options.
Yes, klamat.
Steve Davenport (09:16):
Hedging is not for everyone.
That is a summary of what Ithink you should kind of think
of how to put it in perspective.
Understand your needs for thenext six to 12 months.
Do you have a large purchase ofsomething that you're going to
need cash for?
Therefore, you need to immunizethat cash and make it put it on
hand by selling.
Consider your wants for thesame period.
(09:38):
If you want to change and sellyour house and buy a new house,
or you want a beach house, oryou want a new car and you've
got money aside, maybe you wantto put it in a store or a safer
vehicle instead of in equitieson the market.
Are you nervous or not sleeping?
Well, this can really become aregular event where you start to
(09:59):
hear the news which isoverwhelmingly negative, and it
can make your life a little bitmore difficult.
There are ways to get aroundthat, and this is one of them
Diversify in no or low-tactrisky assets first.
If you've got a taxable accountthat's got a lot of risk in it,
take a little bit off.
(10:19):
Diversify Then.
I think it's learning abouthedging that's important, not
the fact that you do hedge.
I think it's another tool, doyou?
have anything else to add, Clint.
Clem Miller (10:33):
I would just add that I think you'll keep
learning a lot if you listen toSteve's in my podcast.
I think that'll add to yourfinancial knowledge over time
and you'll be more educated asto these different options, so
to speak.
It'll help you with yourability to make money or to
(10:59):
preserve money.
Steve Davenport (11:01):
Steve, that's good.
Thanks for listening everybody.
Thanks everybody.
Welcome everyone to Skeptics Guide to Investing.
I'm Klem Miller and today we'regoing to talk about hedging
stock on overall market exposure.
Steve Davenport and I will diginto the reasons for considering
hedges when there can be riskson the horizon and selling is
not practical.
Steve Davenport (00:20):
Steve Klem, there's a lot to think about in
today's market An ongoingUkraine conflict, expanding
Middle East conflict, potentialblockade in Taiwan recession
talks.
Clem Miller (00:33):
Steve, don't?
We always have areas ofconflict around the world?
Steve Davenport (00:38):
Not really, klem.
I think that your top 10 risksmention this and they all seem
to have just a little bit morelikelihood now.
The best time to buy anumbrella is before it starts
raining.
These are ideas which are notfor everyone.
When you are retired and mostof your assets are in your IRA
or 401K or other non-taxableaccount, selling can be easy to
(01:00):
lower your risk.
What I'm discussing is forsomeone with taxable assets that
may be close to retirement.
These individuals may havelarge gains and they want to
continue growing the assets.
Another example might be peoplewith a large Nvidia position.
Clem Miller (01:16):
Well, okay, Steve.
So how do we hedge some ofthese assets?
Steve Davenport (01:20):
Here are the basics.
These are my thoughts and notadvice, just education.
You use something called a putoption and a call option.
A put option gives you theability to sell a stock at a
certain price for a certain time.
A call option gives you theability to buy or call the
shares for a particular time andat a price With the market at
(01:43):
about 500 on the SPY or 5000 onthe SP index.
Think about a six to nine monthperiod.
You may want to include theelection 10 to 15%, down at 425
to 450.
These are parameters that youcan change.
Clem Miller (02:03):
So, steve, these are short-term periods.
Are we really skipping thelong-term part of investing?
Steve Davenport (02:10):
Most individuals don't need options,
but it is wise to understandthey're available.
Here are some numbers to thinkabout market multiples of 23 to
24 times versus an average of 18.
Higher rates for longer willmake banks and commercial real
estate suffer.
Upchecks in car and credit tolink with Cs, Inverted yield
(02:31):
curve is still in place and theUS military is stretched with
multiple areas of conflict.
Do you ever think about hedges?
Clem Miller (02:41):
Okay, so I like buying high quality names and I
like to hold them for a longtime.
To me, I think, over the longrun, the market works out.
So no, I don't really thinkabout options, but certainly
there are a lot of people outthere who could benefit from
them.
Steve Davenport (03:00):
Yeah, I would agree with you and say that
these are not for the typicalinvestors.
How do you think aboutindividuals?
How do you think individualsshould think about hedging?
21% is on the lower side ofhistoric numbers.
The S&P September 425 options,the SPY, are at about 0.85% and
(03:26):
the 450, which are closer to 10%down, are about 1.3%.
Clem Miller (03:34):
Steve, let me ask you about those numbers.
Can you tell me what thosenumbers refer to when you talk
about September 425 and 0.85%and so on?
Our average investor may not befamiliar with those numbers.
Steve Davenport (03:50):
When you think about the strike price, that's
the price that you can sell.
If you own the SPY or anotherindex one, you would buy the
option, the put option, at 425and by buying that put option
you gain the ability to sellfrom now until September.
So if there is a decline, theprice of that option will go up.
(04:13):
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 dateon a lot of things in the market
(04:33):
.
So I think that it's not a badthing to consider.
Clem Miller (04:41):
Okay, so obviously these are complex kinds of
financial instruments and ofcourse, there's many different
ways to accumulate concentratedpositions, For example, those
who accumulate individual stocksthrough their work or inherent
hot stocks over time.
(05:02):
Here's how I look at largernames or exposures in my
portfolio.
I do have some concentratedpositions, but a few
concentrated positions, butoverall in my portfolio I hold
about 50 stocks, so I would saythat I really am fairly
(05:24):
diversified.
Steve Davenport (05:26):
Sure, I know this is a first world problem to
have too much stock.
I think everyone should talk toa tax or investment advisor
about what is too much.
My point is there can be timesto step back and reevaluate.
Considering an idea and how youfeel about a 20% decline is
healthy, just like a littleskepticism.
Clem Miller (05:50):
Steve, I'm shocked.
Shocked that you're bringing upskepticism again.
Should we just carry on and nottalk about 20% to 30% declines?
Silence is golden.
Steve Davenport (06:01):
I'm not sure what silence is the answer Clem,
whether we talk about declines,recessions, personal finance or
human rights.
Clem Miller (06:12):
Well, I think that is.
I think those situations, allof those things that you
mentioned, need to be considered, but I think we need to be
careful about our money, and Iknow that you're thinking about
options as a way to be careful,and I'm thinking more about the
(06:35):
long run and not missing out onupside.
Steve Davenport (06:39):
Sure, there's inflation, there's long run.
There's a lot of things tothink about, and I'm not saying
this is ever going to be theanswer all the time, but I think
that if you have troublesleeping at night, if you're not
sure about your investments, ifyou feel like you have to be in
something because you need tomake up for lost time in the
market because you started late,there could be reasons that
(07:02):
you'd want to do something.
So I believe that nobody caresabout your assets as much as you
do.
So you need to know what youroptions are.
Ha ha.
Clem Miller (07:17):
So I mean, really, what we're talking about here is
the difference between assetpreservation and asset
accumulation, and those who areinterested in asset preservation
probably can benefit a lot fromoptions.
Do I have that right?
Yeah, I think so.
Steve Davenport (07:35):
I mean, I think that we're in a period where
there's a higher feeling of risk.
Some people can look past thatfeeling and put it in its place.
Other people have trouble withthat and my point is markets are
not the same for everyone.
They're experience level, theirfamily situation and their own
economics.
So I think it's really aquestion about behavior and I
(08:00):
welcome the discussion because Ithink behavioral is really an
area that we start to talk about, as well as fundamentals and
quantitative reasons.
There's a quote a recession iswhen your neighbor loses his job
.
A depression is when you do.
Risk is not beating of abenchmark or losing purchasing
power, risk of losing income orof losing the value of the asset
(08:26):
.
One defines the riskdifferently.
Clem Miller (08:31):
So, steve, my investing, my experience with
investing is really one oftrying to accumulate assets, and
I feel like I'm doing a prettygood job with my personal
investment portfolio.
I'm pretty happy with what I'vebeen able to do, but I think
(08:54):
that I'm in a different positionthan a lot of people, because I
follow individual stocks veryclosely and I follow markets
very closely, and I know a largepart of our audience doesn't do
that, and so maybe they'llbenefit from having options.
Yes, klamat.
Steve Davenport (09:16):
Hedging is not for everyone.
That is a summary of what Ithink you should kind of think
of how to put it in perspective.
Understand your needs for thenext six to 12 months.
Do you have a large purchase ofsomething that you're going to
need cash for?
Therefore, you need to immunizethat cash and make it put it on
hand by selling.
Consider your wants for thesame period.
(09:38):
If you want to change and sellyour house and buy a new house,
or you want a beach house, oryou want a new car and you've
got money aside, maybe you wantto put it in a store or a safer
vehicle instead of in equitieson the market.
Are you nervous or not sleeping?
Well, this can really become aregular event where you start to
(09:59):
hear the news which isoverwhelmingly negative, and it
can make your life a little bitmore difficult.
There are ways to get aroundthat, and this is one of them
Diversify in no or low-tactrisky assets first.
If you've got a taxable accountthat's got a lot of risk in it,
take a little bit off.
(10:19):
Diversify Then.
I think it's learning abouthedging that's important, not
the fact that you do hedge.
I think it's another tool, doyou?
have anything else to add, Clint.
Clem Miller (10:33):
I would just add that I think you'll keep
learning a lot if you listen toSteve's in my podcast.
I think that'll add to yourfinancial knowledge over time
and you'll be more educated asto these different options, so
to speak.
It'll help you with yourability to make money or to
(10:59):
preserve money.
Steve Davenport (11:01):
Steve, that's good.
Thanks for listening everybody.
Thanks everybody.
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