Volatility and some portfolio protection

The main thing I wanted to touch on was volatility which is fairly low again after spiking late January. On rare occasions I may examine using this reduced volatility to provide a little further protection by buying S&P 500 put options and I have elected to do so today. A few reasons have lead me to this.

Firstly, the risks in my shorter term derivative trading have been reduced having profited recently on the AUD decline, having now a worst case break even on a long coffee position that looks promising, and the recent Dow shorts have at least started in the right direction. Secondly and importantly the VIX is still historically quite low, albeit not near all-time lows. Looking back over more than 2 decades I would summarize it is being in the lower quartile of average ranges, so buying protection you could argue is reasonably cheap. Thirdly I have recently wrote about some discounts to NTA in the LIC space widening. Also there is some interesting corporate plays going on in KBC, AIQ. Potentially we could still see various forms of activism take place in other LICs such as HHV, TGG, CYA, AGF, HHY. Interestingly, Wilson Asset Management may be driving all of these so they may be busy. Therefore, we may need to be patient. So by owning some S&P 500 puts I synthetically at least reduce the equity beta in the portfolio at a time where I feel markets are vulnerable. This gives me room to manoeuvre to maybe get involved in some of these activist plays or hold already long positions for longer. I have bought put options quite out of the money such that were the S&P 500 decline sharply to below 1800 before the 4th quarter this year I estimate it will offer me protection for about 16% of the portfolio from 1800 downwards. As I said I see right now as a very cheap way of owning protection and quite happy for them to expire worthless because I feel I can make this up and more at the same time on possible shorter term activist plays. If the S&P 500 rises in the short term I may elect to repeat this trade for further protection. Where the market is now looks to be a fairly key support level many shorter term traders are watching. I read a recent investor sentiment survey showing that many investors were bearish yet by the same token they had not reflected that in their positioning. To me that indicated a lot of investors sitting on big gains from the long bull market with their fingers poised on the sell trigger to sit on the sidelines soon, so the potential for volatility to spike is maybe greater. My cash equivalents sit at 35% now without taking into account this options protection which is hard to measure as it kicks in at lower levels and can be influenced by movements in pricing of volatility also.



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