Barney Franks is attempting to make shorting stocks all but impossible. Individual investors need to know what options are out there to help them protect their hard earned equity portfolios. The stock index futures offer direct hedges to the Nasdaq, Dow, S&P 500 and Russell 2000 indexes. These markets cover everything from blue chips to heavy tech and small cap. They also trade in various size contracts to help tailor hedge positions to your underlying investments.
At these levels, the small contracts have approximately the following cash values:
Market Cash Value Margin Requirement
S&P 500 $56,500 $5,625
Dow Jones $52,500 $6,500
Nasdaq $18,750 $3,500
Russell 2000 $ 63,500 $5,250
Using the above values, one can see the effectiveness of using futures to hedge an equity position, rather than a Contra, Profund or, other inverse equity mutual fund through the following example.
John Doe has $250,000 in equity positions through individual stocks, mutual funds and retirement plans. John is afraid that the market’s rally has run its course and given the overall economic outlook, would like to be able to protect himself in the event of a downturn. Unfortunately, John has had some of the individual stocks for so long that his basis makes selling them and paying taxes an unappealing option. Several of his mutual funds are held in various retirement accounts run by managers who don’t solicit investment advice from their clients on a regular basis. Finally, John has another $75,000 in cash, short term rates and money markets. He considers this his operating cash for any opportunities or emergencies that might come up. So, what can John do protect his self in the event of a market downturn without tying up all of his free cash?
Assuming he would like to hedge half of his portfolio, he would determine the makeup of his holdings to see how he’d like to balance his hedge – small cap, blue chip, tech, etc. Now, he wants to give himself room for another 10% higher in the equities due to the “January Effect” or, market exuberance. Therefore, the free cash needed for this strategy would be approximately, $16,000 in margin to carry the equivalent of a $125,000 short equity mutual fund. Plus, he’s going to need an extra $12,500 to provide a cushion of another 10% rally in the equities. His total free cash outlay is $28,500. Thus, he effectively hedges half of his equity position while tying up only 25% of his operating cash.
As the Barney Franks have their way with allocating investor opportunity, it will become ever more important for the individual investor to know what his options are and how to use them.
Please call with any questions.
Andy Waldock
866-990-0777
