{"id":2023671,"date":"2015-05-20T10:56:50","date_gmt":"2015-05-20T05:26:50","guid":{"rendered":"http:\/\/stockviz.biz\/index.php\/?p=2023671"},"modified":"2015-05-20T18:42:51","modified_gmt":"2015-05-20T13:12:51","slug":"practical-momentum-part-iii-hedging","status":"publish","type":"post","link":"https:\/\/stockviz.biz\/index.php\/2015\/05\/20\/practical-momentum-part-iii-hedging\/","title":{"rendered":"Practical Momentum Part III – Hedging"},"content":{"rendered":"

Introduction<\/h3>\n

In Part II<\/a> of our Practical Momentum series, we saw how adding a volatility adjustment significantly improved portfolio returns. However, we were left with a nagging observation that long-only returns were much higher than long-short returns. The problem with a long-only futures portfolio is that draw-downs can wipe you out. But what if we hedged the portfolio?<\/p>\n

You can hedge a portfolio in two ways: (a) buy individual put options, and (b) calculate the beta of the portfolio and short an appropriate multiple of NIFTY futures. The problem with option (b) is that it will not protect you against idiosyncratic risk. For example, say you are long a pharma stock and the USFDA issues an import alert, the stock will tank irrespective of the NIFTY. So for the purposes of this simulation, we will try option (a)<\/p>\n

Hedged Long-Only Momentum<\/h3>\n

With 5 long-futures hedged with long put-options below the purchase price:<\/p>\n

black line shows long-only; red<\/span> shows hedged long-only<\/small><\/p>\n

\"hedged.momentum\"<\/p>\n

A portfolio hedged with single-name put options performs poorly:<\/p>\n