Biggest Hedge Fund in the World Added a Hedge

When Ray Dalio, founder of Bridgewater, the largest hedge fund in the world, buys put protection on the S&P 500, people should pay attention. It was all over the business news media late last week. I’ve said for years that BNN viewers should read everything Dalio writes—including options!

What Dalio may have done was use an option position called a “collar”: the purchase of a put paid for by writing (selling) a call. There are a number of ways this can be implemented. According to some reports, it looks like he added the strategy at a debit, meaning a cost to the fund of 70 bps (0.7%). Looking at the return-to-risk ratio of a costless collar in the diagram is the basis for understanding how this strategy works. Dalio paid a premium to add the hedge, but it can be done for free. Let’s look at the costs of the hedge to figure out what he did.

An April at-the-money (ATM) put for April 17th expiry trades at $11.29 at Friday’s close. To calculate the dollar value of 70 bps, it’s approximately 70% of the current $311 value that the SPY ETF is trading at or about $2.18.

To pay the ($9.11) balance of the cost for an ATM 311 put ($11.29-2.18), he may have sold a 314 Call for $9.18. That would allow him to stay long and earn the dividend between now and April (0.8%) plus about 1% in terms of potential capital gains between 311, the current level, and 314, where he would have sold the upside away with his short 314 put position. This collar would protect 100% of any downside. The return-to-risk ratio of adding this hedge with the markets so overbought is excellent.

One of the major benefits of a collar strategy is that it allows you to stay invested in the stocks you like and not trigger a tax event when they are sold— versus using the option strategy to mitigate (hedge) the market risk.

This strategy is something I use for clients. Currently, we have similar hedges in our QW growth portfolio. We are long some of the best dividend paying stocks globally, but the downside market risk is hedged with put protection. It allows us to still grow the portfolio by focusing on owning the best higher yielding companies while mitigating sleepless nights.

I love the use of option strategies to mitigate volatility risks as well as generating yield. We’re often asked, “Is it time to sell?” If you understand how to use options, you may not have to sell. Increasingly, with the bond market impaired from a real yield perspective, a basket of higher yielding equities is very attractive if you can manage the market risk. I talk about many of these types of option strategies in my current roadshow. We are in the closing stretch of our BNN Investors Guide to Thriving Tour (Fixing Fixed-Income).

Bond yields are likely to remain low for many reasons, one of which is global demographics and the other is the massive existing debt burden. As we age, we need our money to last longer and low real interest rates (after inflation eats purchasing power) are a huge tax on incomes. And, while rising stock markets help, they only really support the top third of the population who benefit from the exposure. The average person is doing okay, but the median person is increasingly worse off. The bottom half of people have little-to-no income impact from the wealth effect of rising asset prices due to low savings rates but are hurt most from low rates in retirement as they require the safest income. The safe bond part of your portfolio is broken, perhaps impaired for decades. You will need to get creative to enhance your real return on your fixed-income.

Gold is one way of improving your portfolio performance. Come to our Tour and learn how. Click here to register for free and as always we ask for volunteer donations to one of our two favourite charities. Children’s cancer research at the Sick Kids Hospital and Alzheimer’s and dementia research at the Baycrest Hospital.


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