ETFdb Logo
ETFdb Logo
  • ETF Database
  • Channels
    • Active ETF
    • Beyond Basic Beta
    • China Insights
    • Climate Insights
    • Commodities
    • Core Strategies
    • Crypto
    • Direct Indexing
    • Disruptive Technology
    • Energy Infrastructure
    • ETF Building Blocks
    • ETF Education
    • ETF Strategist
    • Financial Literacy
    • Fixed Income
    • Gold/Silver/Critical Minerals
    • Innovative ETFs
    • Institutional Income Strategies
    • Leveraged & Inverse
    • Managed Futures
    • Market Insights
    • Modern Alpha
    • Multifactor
    • Night Effect
    • Portfolio Strategies
    • Responsible Investing
    • Retirement Income
    • Richard Bernstein Advisors
    • Tax Efficient Income
  • Tools
    • ETF Screener
    • ETF Country Exposure Tool
    • ETF Sector Tracker Tool
    • ETF Database Categories
    • Head-To-Head ETF Comparison Tool
    • ETF Stock Exposure Tool
    • ETF Issuer Fund Flows
    • Indexes
    • Mutual Fund To ETF Converter
  • Research
    • ETF Education
    • Equity Investing
    • Dividend ETFs
    • Leveraged ETFs
    • Inverse ETFs
    • Index Education
    • Index Insights
    • Top ETF Sectors
    • Top ETF Issuers
    • Top ETF Industries
  • Webcasts
  • Themes
    • AI ETFs
    • Blockchain ETFs
    • See all Thematic Investing ETF themes
    • ESG Investing
    • Marijuana ETFs
  • Multimedia
    • ETF 360 Video Series
    • ETF of the Week Podcast
    • ETF Prime Podcast
    • Video
  • Company
    • About VettaFi
    • Get VettaFi’ed
  • PRO
    • Pro Content
    • Pro Tools
    • Advanced
    • FAQ
    • Pricing
    • Free Sign Up
    • Login
  1. ETF Investing
  2. Avoid These 3 ETF Hedging Mistakes
ETF Investing
Share

Avoid These 3 ETF Hedging Mistakes

Stoyan BojinovJun 28, 2016
2016-06-28

ETFs have found their way into countless portfolios, and many investors have even grown accustomed to utilizing them in more strategic ways, whether to add tactical exposure or help with hedging.

However, when it comes to protection strategies in particular, investors are prone to committing a number of avoidable mistakes all too often. Be sure to steer clear of these 3 ETF hedging mistakes:

1. Being Late

Perhaps the biggest mistake with hedging is that most rush to do it after the fact. That is, investors scramble to protect their portfolios only after their positions have started to incur steep losses. Once a market pullback has begun, you can expect to pay a higher premium for protection in the options market, which is where many will turn to.

The other problem is market timing related. If you rush to hedge after a downturn has already developed, and let’s say you avoid the options premium surcharge and bought an inverse equity ETF instead, you will still likely get suboptimal protection for your money at that point. Why? Because your entry is so important when it comes to executing a tactical move like that, and improper timing can lead to a costly hedge.


Content continues below advertisement

2. Not Hedging for the Right Exposure

Another common oversight when it comes to hedging with ETFs is related to investors not constructing a specific-enough plan, especially in the case of protecting against event risk. One mistake to avoid is mismatching your exposures.

For example, if you want to hedge your equity portfolio consisting primarily of small caps, be sure to select the appropriate instrument; for instance, choosing an inverse Russell 2000 ETF over an S&P 500 one.

The other lack of specificity is more quantitative in nature.

In the case of event risk, say the Greek Debt Crisis, ask yourself what you’re really trying to hedge for — that is, what level of downside do you want to protect your portfolio against and for how long? For starters, how will you estimate what percentage of your portfolio is exposed to Greek-related assets? What percentage drop in the S&P 500 will you assume when modeling what may happen to your portfolio? And the list goes on.

Sometimes when you can’t quantify the risk exposure in your portfolio related to a certain event, a good rule of thumb is to not modify your portfolio.

3. Over-Hedging

There is a plethora of evidence that supports long-term investing. So if you’re a long-term investor, trying to protect your portfolio from every correction or event risk is a surefire way to pay a high premium for insurance you never really plan to use. Put another way, you may actually do more harm to your portfolio if you try to actively protect it rather than leaving it be (just make sure to diversify and rebalance).

Plain and simple, you probably don’t need to hedge for event risk unless you wish to be very tactical.

A Better Way to Hedge With ETFs

If you’re set on hedging, consider the following tips:

  • Look ahead to event risks in the calendar if you want to be tactical (and on time!). The free calendar at Forex Factory is a great resource for staying on top of events around the globe.
  • Consider more options strategies. While premiums are high during stressful times in the market, another way to hedge existing exposure is to sell options.
  • If there’s an event coming up that has you worried about one of your positions, it’s probably because that position is too risky to begin with — meaning that you bought more than intended or at a price you didn’t feel comfortable paying.
  • You’re probably better off rebalancing your portfolio (when was the last time you did that?) than trying to hedge for any one event.

The Bottom Line

ETFs can come in handy for executing a plethora of risk-on and risk-off strategies. With hedging, be sure to ask yourself some basic questions before pulling the trigger. For starters, is it too late to hedge? Can you still do so in a cost-effective manner? Can you quantify the risk in your portfolio that you wish to hedge against?

For most long-term investors, the cost of hedging for event risk may be too high, not even counting market timing risk. So it might make the most sense to stick with a hands-off approach during high-volatility periods.

Follow me @SBojinov

» Popular Pages

  • Tickers
  • Articles

Jun 09

How Advisors Use the Small-Cap ETF 'QWST' in Portfolios

Jun 09

S&P 500: The Battle on Two Fronts

Jun 09

This Is How New Bulls Are Born

Jun 09

Main Management Market Note: June 9, 2023

Jun 09

European Carbon Allowances Up 10%: The Summer Guide

Jun 09

A Complete Comparison of Top U.S. Real Estate ETFs

Jun 09

Could Now Be a Good Time for Value ETFs?

Jun 09

Fine Tuning Your Index Exposure With Direct Indexing

Jun 09

BNDI Generates Better Returns, Yields in Core Bond Allocations

Jun 09

Issuer League: WisdomTree and Dimensional Are Up

FNGS

MicroSectors FANG+ ETN

FNGU

MicroSectors FANG+ Index 3X...

QQQM

Invesco NASDAQ 100 ETF

SMH

VanEck Semiconductor ETF

VGT

Vanguard Information...

XLY

Consumer Discretionary Select...

IYW

iShares U.S. Technology ETF

BOTZ

Global X Robotics &...

VUG

Vanguard Growth ETF

FTEC

Fidelity MSCI Information...

Loading Articles...
Our Sites
  • VettaFi
  • Advisor Perspectives
  • ETF Trends
Tools
  • ETF Screener
  • Mutual Fund to ETF Converter
  • Head-To-Head ETF Comparison
  • ETF Country Exposure Tool
  • ETF Stock Exposure Tool
  • ETF Database Pro
More Tools
  • Financial Advisor & RIA Center
Explore ETFs
  • ETF News
  • ETF Category Reports
  • Premium Articles
  • Alphabetical Listing of ETFs
  • Browse ETFs by ETF Database Category
  • Browse ETFs by Index
  • Browse ETFs by Issuer
  • Compare ETFs
Information
  • Contact Us
  • Terms of Use and Privacy Policy
  • © 2023 VettaFi LLC. All rights reserved.

Advertisement

Is Your Portfolio Positioned With Enough Global Exposure?

ETF Education Channel

How to Allocate Commodities in Portfolios

Tom LydonApr 26, 2022
2022-04-26

A long-running debate in asset allocation circles is how much of a portfolio an investor should...

Core Strategies Channel

Why ETFs Experience Limit Up/Down Protections

Karrie GordonMay 13, 2022
2022-05-13

In a digital age where information moves in milliseconds and millions of participants can transact...

}
X