Getting Paid to Hedge the Gold Miners ETF
August 28, 2013
Dave Pinsen, Portfolio Armor
Although the SPDR Gold Trust ETF (NYSEARCA:GLD) was up close to 1% on Tuesday, shares of the Market Vectors Gold Miners ETF (NYSEARCA:GDX) were down more than 4% on the day. Nevertheless, it was still possible for GDX longs to get paid to hedge their shares as of Tuesday’s close, using the negative cost collar below.
This was the optimal collar*, as of today’s close, to hedge 500 shares of GDX against a >11% drop between today and March 21st, for an investor willing to cap his potential upside at 11% over the same time frame.
As you can see at the bottom of the screen capture below, the net cost of this optimal 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 $10 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 BlackBerry (Nasdaq:BBRY).
*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. Portfolio Armor uses an algorithm developed in conjunction with a post-doctoral fellow in the financial engineering department at Princeton University to scan for optimal collars.
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