Wednesday, May 13, 2009

TWM vs. SDS: Hedging a Stock Portfolio with minimal small cap exposure

Before leaving HQ, I thought that I would mention that I follow the price action of two double shorts for stock indexes, SDS and TWM even though I do not own them.  I am in a continuous process of evaluating the double shorts as hedges, and I used both TWM and SDS effectively in 2008.  I noted in a blog from yesterday that TWM might make a better hedge even if I did not have any small cap stocks due to its volatility.  Today, it rose $4.31 or 9.13% compared to SDS rising 4.78%. SDS: Summary for PT ULTRSHRT SP500 PS - Yahoo! FinanceTWM: Summary for ULTRASHORT RUSSELL20 - Yahoo! Finance
This would indicate TWM may have more bang for the buck as a hedge in the Unstable VIX Pattern.   The volatility index for the Russell 2000 rose 7.22% today (^RVX at Yahoo). The VIX was up 5.82%.     

From the start of my volatility models I tried to develop a timing technique to use the double shorts as hedges based on the degree of volatility.  I found that the best use of the SDS hedge in an Unstable VIX pattern was after a move from an elevated volatility of over 30 to below 20. This would be the time for purchase, the market would be rising and SDS falling in value.  Then it would be sold on a spike to 30 or so.  That worked only during the Phase 1 pattern of the Unstable VIX, where there was frequent movement between 20 to 30 or a few points higher.  So, as I discussed in several prior blogs, I could sell SDS at 30 say and then buy it back at 20 or lower, and so on.  This broke down after the Lehman failure, when I had no hedge on, a dumb move in retrospect, since LB was content to profit trading the hedges rather than thinking about the big picture and using the hedges as insurance.   

So it is a work in progress as to how the use the double shorts now, if at all, and what to do when the next bear comes around.  Anyone else thinking about the next bear market after this one is over?  The only hedges that I own now are double shorts for the U.S. treasuries as a hedge for my corporate bond portfolio, and I have sold some TBT to lock in a profit. Sold TBT/Emerson/More on Dynamic Asset Allocation   I am extremely critical of LB for doing that and it has reverted to its old habits from last year. 

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