Getting Paid To Limit Your Downside On VXX

Getting Paid To Limit Downside On VXX

Since inception, the iPath S&P 500 VIX Short Term Futures ETN (NYSE: VXX) has declined nearly 99%, but it’s up about 10% so far this week as the government shutdown continues. For VXX longs savoring their gains since Monday, but wary of downside risk going forward, below is a way you can get paid to hedge.

Hedging With A Negative Cost Optimal Collar

Pays you to hedge, 20% upside cap.

If you’re willing to cap your potential upside at 20% over the next several months (although, realistically, who probably wouldn’t be in this position that long), this was the optimal collar, as of Wednesday’s close, to hedge 500 shares of VXX against a greater-than-20% drop over the same time frame.

As you can see at the bottom of the screen capture above, the net cost of this collar was negative, meaning you would have gotten paid to hedge in this case.

Note that, to be conservative, Portfolio Armor calculated the cost of this hedge by using the bid price of the call leg and the ask price of the put leg. In practice, you can often sell calls for more (at some price between the bid and ask) and buy puts for less (again, at some price between the bid and ask), so, in actuality, an investor opening the optimal collar above would likely have netted more than $360 to do so.

Possibly More Protection Than Promised

In some cases, hedges such as the ones above can provide more protection than promised. For a recent example of that, see this post about hedging shares of the SPDR Gold Trust ETF (NYSE: GLD).

*Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance PhD to sort through and analyze all of the available puts for your stocks and ETFs, scanning for the optimal ones.

**Optimal collars are the ones that will give you the level of protection you want at the lowest net cost, while not limiting your potential upside by more than you specify. The algorithm to scan for optimal collars was developed in conjunction with a post-doctoral fellow in the financial engineering department at Princeton University. The screen captures above come from the Portfolio Armor iOS app.

The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

Posted-In: Options Markets Trading Ideas

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