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Tuesday, 7 February 2012

Protecting my recent paper profits - Hedging

First of all, no one is more surprised than me on the STI's recent rise from this January 2012!

Being 50% vested, I am not complaining! A red-packet from the market for Chinese New Year!

Of course I can take some money off the table (like some of my fellow bloggers in my blog list); if and when the STI rediscover gravity, I can always buy back at the lower prices - now that's more easily said than done!

Unfortunately (or fortunately!) most of my core holdings will be declaring or paying their dividends to me in the next coming weeks.

Furthermore, selling now will take my vested share to below 50%... Since I am still totally clueless to which direction the STI will go (hands up for those who saw this Jan 2012 rally coming during Dec 11), I better continue in neutral gear. This way, I am always 50% right!

LOL! How's that for positive thinking!?

This morning at 10:15 am, I shorted the SIMSCI (STI index futures).

It's not a short! It's a hedge ;)

I better "hedge" myself knowing how some people have mistaken notions about shortists... (It's not funny - I know! Throw me a bone here lah)

It's not a perfect hedge, but it's close enough.

If STI plunges tomorrow, some of my paper profits will be "rescued" by my "hedged" position in the SIMSCI.

The price I am paying will be the "capped" paper profits if STI were to continue defying gravity. 

From now onwards, I won't be  participating in the STI's rise fully anymore as each rise will be offset by my "loss" in the SIMSCI.

What I've done is to effectively "locked up" my paper profits up till this morning. I've taken my money off the table in another way. "Enough" is good enough for me!

I can also do it with CFD (contract for difference) index. It's just that I am leaving my CFD powder dry for shorting some stocks I've recently put on my short watch list. Just in case Israel strikes...

OK, derivatives and OTC (over-the-counter) products are not suitable for everyone (nor should they be).

To continue my Goldilocks and the three bears analogy, if we don't try ourselves, how do you know what's "just right" for us?

Some are more suited to be specialists; while I am more suited to be a jack-of-all-trades ;)

And are you a specialist because you know yourself well, or are you one by default because you just never ventured beyond equities?


  1. Hi SMOL,
    i think almost all professional investors use hedging in some ways. Till today i have yet to learn to hedge. i realise the pros and cons of hedging. There is really no free lunch in hedging.

    My posting in "Values Buddies"

    You Can’t Hide
    {the most damaging types of risk are those that can be attributed to common wisdom or accepted practice. These risks are hidden behind the veil of conventional wisdom, but they are still there. They are damaging because most people do not understand the extent to which they are exposed to the very real possibilities of loss.
    Consider the common buy and hold strategy for investing in stocks. This is the strategy that mutual funds are mandated to use by federal law. Buy and hold strategy keep you in the markets at all times. Anyone using buy and hold strategy saw their investment value dip from 35 % to 40 % in just the year 2008. A buy and hold strategy carries significant risks. You are exposed to the full risk that the market will drop in value. (In reality, Unexpected Catastrophe causing severe bear market is not “Unexpected.”)}
    The above is an extract from a book about RISKS MANAGEMENT

    (Actually, it happened to me in the worst possible case in 09 March 2009. Don’t you think it’s very scary? And I was not really using buy and hold strategy. I was using “Life Cycle Investing” yet I was caught. But with the Lord’s blessing my portfolio was making a little money by 25 September 2009, Amen).

    Coming back to the present topic - RISK MANAGEMENT

    The question is,
    "Don't you think if I learn to hedge by shorting an ETF correlated inversely to my portfolio such that if my portfolio down by 50% it will be offset by the % of hedging I take. Of course on the upside, my portfolio will make less by the % of hedging too. (There is no free lunch in this world, really.)

    So isn’t this hedging is like assets allocation or re-balancing my portfolio of stocks? It's even more important to hedge if the Market is in the Bull Run now. You would want to protect what you have gained so far. You wouldn't want to lose back too much to the Market when the Bull suddenly turns into a Bear.

    Anyway there is really no free lunch in investment as share by Weijian's
    quotation: -
    "Investors need to pick their poison: Either
    make more money when times are good and have
    a really ugly year every so often, or protect on the
    downside (I suppose hedging) and don’t be at the party so long when
    things are good"

    If I am not mistaken, we can short STI ETF for hedging our SGX portfolio.
    I am really glad to be enlightened if there is a better way. Put or call option as hedge instruments are too complicated for Simple Simon like me. I never like them at all, anyway. But I have never hedged my portfolio because I am not really sure of the benefit to do so. So can I short STI ETF for hedging my portfolio in a Bull Market? Is there anyone care to share his experience of hedging?

    1. Thanks Temperament for sharing your views!

      Most of the time, I would prefer to simply take some profits off the table and "hedge" by being in cash. And I've been doing that since March 2011 last year. From 100% vested to 50% vested.

      I prefer to keep things simple.

      But for this case, I am just showing its good to have some other tools in our backpack for different situations ;)

      I am more of a tease. I show a hint of flesh, but if anyone wants to see more, sorry boys, you got to put a ring on it. LOL!

      Can anyone more experienced help Temperament on his question? I can't answer as I am not a big fan of ETFs. And I may want to write a satire on it later on...

    2. i hate ETF! and you cannot short an ETF on SGX. you cannot short anything on SGX! you also have counter party risk in ETF.

      you can use STI warrent (kind of an option) to trade. but unlike option, you can only long (both put and call). it also has expiry date like an option.

      yes, make it simple, don't use hedging until you are very sure of their advantages. for example, instead of selling all the stocks and pay a high commission, you can use SIMSCI future to hedge. smol, are you really hedging? what are your holdings as compare to SIMSCI component?

    3. if you are not sure thinking you are hedged, you can end up losing on both side.

    4. and for goodness sake (haha), don't try until you thought through all the possibilities.

      don't try for the sake of trying, mistake in trading, yes trading can be very costly.

    5. and lastly, make up your mind, whether you want to be a trader or just an investor.

      for trader it has to be full time! full time! full time! otherwise just lock up your shares and enjoy your life.

      thats my view.

    6. Coconut,


      Readers of my blog know I don't like to talk about specific trades. This post is to merely to show there are alternatives to protecting profits than going into cash.

      And hidden in it is a gentle poke to those who "label" derivatives and OTC products as bad or risky but never tried it!

      I've already said it's not a perfect hedge. In fact, non of my stocks are STI or MSCI component stocks. LOL!

      By the way, you sound like a dad having a cigarette in his hand telling his son not to smoke.

      Somethings we should never try; but some mistakes we all have to make on our own. It's all part of growing up or as part of our financial journey.

      I am cheerleader of making mistakes and failures - how else to know what not to do?

    7. you got me! haha. but i'm not teaching you. i merely speak my mind as though i'm talking to myself.

      "this guy is going .... can't wait to...he should....".

      by the way, i say if you wanted to trade, put all your heart and enegy into it. otherwise don't waste your time and money. remember smallfry, same advise.

    8. alright alright my mistake. got to stop before it goes urgly.

    9. Coconut,

      I don't want to set bad example, but I now more or less full-time of sorts...

      It's just that my style is to trade only a few times a year. I patiently wait for the right risk/reward trade. I am more a medium term trend follower.

      I don't do well with the recent volatility of the past 6 months. That's why I stay on the sidelines.

      This recent hedge is to lock-in my recent gains while I wait to collect the dividends.

      It's not a trade.

  2. Hi SMOL,
    "Somethings we should never try; but some mistakes we all have to make on our own. It's all part of growing up or as part of our financial journey.

    I am cheerleader of making mistakes and failures - how else to know what not to do?"

    You seem to always say the things i like. i use to teach my son so many things in the past. But now i like to stress to him every experience is something to learn. In short i tell him now to always remember "Life is a journey. And the journey is always more important than the destination." Ha! Ha! my toss to"LIFE's JOURNEY"
    Hey! we have a lot of same wavelength; i hope not so much i can not learn anythings new from you. Ha! Ha!

    1. Yes Temperament,

      I am merely a different bottle pouring out the same old wine like everyone else.

      My sword will only be sharpened with friction. That's why you see me (you know where) making gentle pokes to views I disagree with; and I always sugar coat it.

      The intention is invite stronger counter-arguments to help me decide: should I continue using my sword or ditch it for another weapon?


  3. Is hedging same as paying premiums for insurance against uncertainty? Over continuous runs, does the law of averages shows that it is still cost effective strategy?

    1. hedging just like insurance. you can either be an insured or insurer. depends on what kind of strategy you employed.

    2. CW8888,

      This hedge to me is like buying travel insurance. A one time transaction for a specific purpose.

      What I fear: What's the point of collecting 9-10% dividends, and lose 9-10% in capital losses if the market suddenly corrects?

      If market sideways or corrects: I would have locked in the "bonus" capital gains for the past month AND get my dividends. Premium paid is just the cost of the SIMSCI.

      If market zooms up up and away: Then I would get the same above BUT my premium would be not cheap - cost of SIMSCI plus the further potential upside profits foregone... Ouch!

      But that's greed.

      Remember, I've already made my unexpected capital gains from Dec to Jan. I have "enough" ;)

      If I've made $1, I don't really mind paying a few cents to buy insurance premium to protect the downside.

      I don't need to plan long term. In the long term, I would be in Western Paradise!

    3. How much it cost to hedge the portfolio? 0.0X% or 0.X% or 1-3% of portfolio value?

    4. 1 contract of SIMSCI costs around $12 plus per transaction.

      So the cost as of today is more like 0.0X%

      But if STI zooms 10% or more, it would cost me X%... Boo hoo hoo. And on condition I unwind my SIMCI hedge fast!

      People who don't believe in stop-losses should never touch leverage.

      We can also play futures without leverage. Just put up $68,000 for 1 SIMSCI! Who says futures must always be leveraged? But no fun... LOL!

    5. ok fair fair. you defend well haha and i think you have a good run on this one. just honor your cut loss.

    6. The platform to short the SIMSCI is it the same as CFD's? Sorry I am new to shorting.

    7. Shine in Rain (eh, you changed nick?)

      They are different instruments. SIMSCI is an Index Futures traded on SGX.

      While CFDs are OTC products traded between you and your broker. A bit like buying 4D from private sources instead of from Singapore Pools (but legally!)

      Most major brokers allow you to trade CFDs and futures on the same trading platform - its more a matter whether they grant you access to the particular trading screens.

      I would recommend you chat with your broker to find out more. You are paying them commissions. Use them!

      I won't dissuade you (I am bad influence); but I would encourage you to only put in money you can afford to lose. The rest is up to you to experience for yourself!

      Have fun learning by doing!

    8. No, I didn't change nick. Just that my blog name is not my nick LOL.

      I see... I haven't learn on trading futures yet. I meant what type of account allows you to short futures cos I thought normal trading on SGX doesn't allow you to short. Is it also a leveraging account something like CFD's? I know CFD accounts allow shorting.

    9. Oh I see ;

      You have to open a "separate" futures account with your current broker or a futures specialist broker.

      You can refer to this link for an example of the futures products and platforms available: http://www.phillipfutures.com.sg/en/

      As always, shop around at least 3 shops before buying ;)

    10. Oh I see... Thanks for the info. :)

  4. Thanks Coconut!

    I welcome and appreciate your questioning and challenge. It helps improve my own thought processes.


  5. yes smol, everything have both side, especially in trading. always listen whether you currently agreed or not. you put up something, there is always always a counter agruement.

    you know why i like fat blog? i always try to find disagreement and always listen to him to reflexs on myself. like a sparing partner.

  6. unfortunately for me, i received very little critisism.

    1. Coconut,

      I've started giving you gentle pokes ;) Give me time to reciprocate.

      Must test the water a bit mah. Wait you say I no big no small I faint!

      Like flirting, you don't start by jumping all over her on the first date. You start with accidental gentle "brushes" of the hand.


  7. If you have Shorted 1 contract of SIMSCI at 10.15am, taking it as 339.5, you would have lost quite a lot (about $1,640) at today close 347.7. 1 contract might not be enough for you to hedge your portfolio. If you short 10 contracts, that is pretty significant lost. And future contract will expire. You cannot leave it running as paper lost till STI drop. You have to close position to take real lost.

    Is that still a good hedge?

    1. Hello Tony,

      I "shorted" the March SIMSCI contract at 339 as I would unwind this hedge when my 3 core equities holdings will go ex-dividend in March.

      It's a plain vanilla "imperfect" hedge (but close enough).

      Whatever I "lost" in the SIMSCI will be offset by my equities gain. And vice versa if SGX tanks.

      There's no "lost" here. There's only extra capital gains forgone if STI would to go higher than 2950. Plus the cost of this imperfect hedge - small losses or gains will incur which I will consider as part of this hedging costs.

      In normal times, I would have gone into cash, but this time I want to collect my dividends.

      Why risk shooting for this extra dividends and see my stocks get a hair-cut of 15% and more if Israel attacks Iran?

      As for your question, its easy. If by end March if STI is

      1) around 2950 - I would have paid and "lost" the cost of this hedge (like buying travel insurance and coming back safely)

      2) above 3000 - I would have forgone extra capital gains I could have made from 2950 onwards. Sob sob. (At least got some consolation from the dividends)

      3) below 2900 - Phew!


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