Central banks are determined to regain control of inflation and the only logical solution is for them to crash the economy into recession so they can initiate an economic reset. The depth of recession will vary between countries.
With the risk of recession increasing each time central banks raise rates; it is leaving investors confused and unsure how to manage their portfolio. The markets have been extremely volatile and basic economics do not seem to be holding true in today’s markets due to the influence and actions of the central banks. Strong data pushes stocks lower as expectations increase that central banks will have to increase rates even further and for longer to beat inflation, this will take time and possibly take into 2024 before inflation reaches the central banks desired 2% level.
Stocks markets started on the backfoot this year and each time green shoots of hope appear for investors fresh data is released that dash those hopes. This leads to the question; how do you manage your portfolio risk? Many investors simply hold and wait! The cost of constantly entering and exiting stocks can be expensive but just holding on to them in a dropping market is even more costly, so is there anything else that can be done? Thankfully the answer is yes😉
Hedging is a form of protection to manage the risk of a position. Commercials do it all the time to reduce their exposure to currency moves and the cost of raw materials such as commodities, both have been a major impact to certain industries in the past couple of years. The strength of the dollar and Russia’s invasion of Ukraine impacted commodity prices with the latter creating further disruption to supply chains. Then we saw the USD drop considerably and also commodity prices trade lower, which again can be a concern, depending on if you are a supplier or buyer.
If considering hedging a stock portfolio, it is essential to start by assessing the structure of it. Are they multinational companies, small or mid-cap and are they sector specific? Once you have analysed the portfolio it is possible to decide what is the best fit for hedging. If they were U.S tech stocks, then the Nasdaq future index would be best, or small cap then the Russell 2k etc. If you are looking for a more precise hedge then you could look at the sectors, new ones have been listed recently on the CME plus there are European sectors available on Eurex.
As you can see from the lists below there are plenty to choose from for both the U.S and Europe.
Of course, apart from hedging they can be used to generate revenue. Imagine the opportunities during Covid from selling the Travel & leisure sector or due to the Russia invasion of Ukraine buying the oil & gas sector!
Another method of hedging that is useful are Options. These provide flexibility and by buying options (can be used to create long or short positions) the maximum cost is limited to the premium. These do not require any micromanagement as the maximum cost to the option buyer is the premium. The buyer has the right but not the obligation to buy (calls) or sell (puts) at a specific price in the future. Note: the seller has unlimited risk exposure.
Sectors
E-mini S&P (CME)
- Regional Banks Select Industry futures
- Insurance Select Industry futures
- Biotechnology Select Industry futures
- Oil & Gas Exploration & Production Select Industry futures
- S&P Retail Select Industry futures
- E-mini PHLX Semiconductor Sector Index futures
- Utilities
- Technology
- Communication Services
- Consumer Discretionary
- Consumer Staples
- Energy
- Financial
- Health Care
- Industrial
- Materials
- Real Estate
Eurex
- Automobiles & Parts Futures (FESA)