With the sell off this morning I’m taking the opportunity provided by a spike in volatility to take some profit from the hedge and soften it in the Long / Short Hedged portfolio. I’m taking all profit from the hedge and buying new long positions with it. In addition, I’m selling 1/3 of the aggressive hedge (mid term put options, VXZ, or XVZ) and buying a short of the S&P 500 Index (or using SH). Usually, the longs in the portfolio have dropped enough that the new allocations are fairly close to a 50% long and 50% hedged position after a rebalance. But due to the large increase in volatility without much price damage in the market since 8/21/15 (when my market risk indicator signaled) the new allocations have a slightly smaller hedge than is normal after a rebalance. The new allocations for the Long / Short portfolio are as follows.
53% Long stocks that I believe will outperform in an uptrend (high beta stocks)
15% Short the S&P 500 Index (or the ETF SH)
32% Aggressively hedged (mid term put options, VXZ, or XVZ)
The idea in taking profit from the hedge is that I can’t pick an exact bottom, but I’ve got 10% to 20% gains in my hedging instruments while many of the longs in my portfolio are down from their peaks by similar amounts. By taking profit from the hedge I’m able to accumulate more shares of the stocks I want to own over the long term. The reason I soften the hedge from volatility instruments to a simple short of SPX is that it appears the market is due for some consolidation and likely lower range days. A short of SPX won’t lose as much as an instrument that falls as volatility comes out of the market.
My market risk indicator is still warning so the Volatility Hedged portfolio is still 50% long the S&P 500 Index (SPX) and 50% aggressively hedged (with mid term put options, VXZ, XVZ, etc.) for official tracking purposes. However, if you use high beta stocks for the longs (as I do for my personal portfolio) then you might want to consider softening the hedge similar to what I outlined above with the Long / Short portfolio. Those are the rough allocations I now have on my personal Volatility Hedged positions.
The Long / Cash portfolio is still 100% in cash.