As we see market volatility bounce up and down, the focus of investors continues to shift largely on the direction of this volatility with respect to whether or not hedges are viewed as valuable. With the VIX Index, a measure of the volatility of the overall market, now fluctuating at a lower level in recent weeks from the levels we saw around the March lows of the market, many investors may have lost their impetus to initiate, or maintain, hedges in their portfolio.
In this article, I’m going to explain why hedging one’s portfolio may make more sense now than ever.
First of all, lower levels of volatility translates directly to lower hedging cost overall. This is because options contracts, the most common way to hedge an equity portfolio, are priced based on the implied volatility of a given stock.
Being able to pin down hedges today for dates further down the road at a lower cost is obviously advantageous to the average investor.
Secondly, I believe it is important to recognize that potential structural damage has been done to the global economy via this pandemic. Investors may be overly bullish on earnings outlooks moving forward based solely on Central Bank support.
After all, that level of support may or may not be feasible to maintain over an extremely long period of time. The reality that Central Bank purchases of various asset classes is technically an inorganic/unsustainable policy over very long periods of time should require some thought into hedging portfolio positions now trading at or near all-time highs in many cases.
Invest wisely, my friends.
