Friday, January 27, 2012

Establishing some Hedges on Emerging Markets

One of he goals of CCI portfolios is to lose less in down markets, with the trade off being making less in up markets.  Last year, CCI's portfolio of non-US countries performed only slightly better than the global markets. (i.e. loss only a very little less).  It seems this just once again seems to prove the point that just trying to pick the right stock/country is not really enough to improve your risk/reward.  It seems like some amount of hedging needs to be done to improve a portfolio's risk/reward.   This year, CCI plans to put more hedges in place around global funds.  To that end, two option positions were established this week.

1). CCI has a full, long  position in the major Brazilian ETF (EWZ).  This fund is up about 10% so far this year.  An option position to hedge against a stall or fall in this market's rise was established.  Specifically an unbalanced butterfly spread was discussed on  Given the overall long position of CCI in EWZ this seemed to make a tremendous amount of sense.  Specifically a Feb $62/$63 - $66/$68 butterfly was established for a credit of $.94/contract after commissions. A few scenarios:
  • Best case for this trade - the stock stalls in the $63 to $66 range and the portfolio pockets the $.94/contract (nearly 1.5% gain).  This is a relatively narrow range but is offset by the relatively minor impacts to the overall portfolio if the etf trades out of that range as defined below:
  • Best case for the position - the stock rockers well past $68.  This trade loses $1.06/contract, but the long holding goes up substantially.  Admittedly, doing this trade will be a drag on performance, but the position will still be up nice;y
  • Worse Case - The etfs falls below $62.06.  That is the break even for this trade and this trade will lose an insignificant $.06/contract.  However, the long portion of the portfolio will of course be down.
So this trade barely loses if the market falls, is a moderate drag on the position if the etf continues to soar, and enhances returns if the etf  consolidates at this level for awhile.

2). As previously posted, CCI started the year intending to build a position in the emerging market etf (EEM).  However, with this fund also increasing by 10% this year, CCI is thinking it might be time for some consolidation.  Hence, earlier this week CCI bought the Feb $38, $40, $42 butterfly for $.52.   This trade profits if EEM slides back to around $40 in the next three months.  This is a very modest position size and in essence what seemed like a fairly cheap way to be have some short exposure in the global portfolio. As of Friday, EEM is trading around $42.50.  So currently, this is not looking too good.

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