Our Market Risk Indicator closed the week in negative territory. This signal caused us to aggressively hedge our portfolio. We’re effectively 50% Long and 50% short, but our shorts consist of instruments that will benefit from increased volatility in the market. Some examples are puts against our long positions or mid term volatility like VIXM or VXZ. A lesser alternative would be an actively managed bear fund similar to HDGE.
The long portion of our portfolio continues to be stocks that we believe will outperform the general market over the long run.
This move in the portfolio is not a prediction of lower prices in the market. Rather, it reflects enough increased risk that we want to insure our portfolio. As we’ve noted before, our Market Risk Indicator has many false signals that are usually short in duration. If this signal is false we expect to take a small loss which we consider paying for insurance. If the signal proves to be correct we expect to make money as volatility increases and the market accelerates downward.
Our current hedge ratio is 1.
The green lines in the above chart represent removing hedges and adding long exposure to the portfolio. The yellow lines represent removing longs and replacing them with a simple short of the S&P 500 Index. The red lines represent aggressive hedging with puts or mid term volatility.