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Portfolio hedging

Who secures your portfolio in case of turbulences?

The following statements are provided for general information purposes solely and relate only to considerations of general nature. The content has not been prepared for specific financial situations or the particular needs of any specific investor and does not constitute advice or an offer. For more information, please refer to our Terms of use.

There are numerous ways to protect a stock portfolio from price losses during a bear market.

The simplest option would certainly be to sell all positions. However, depending on the size of the portfolio, this is associated with high transaction costs and is not very practicable, as the positions have to be rebuilt if an investor wants to continue participating in the market at a later date, which in turn incurs transaction costs. In addition to the costs, there are other reasons why investors prefer to hedge their portfolio or individual equity positions against price losses rather than sell them: for example, an investor may want to continue to exercise his voting rights or not forgo any dividends.

The following example shows how a portfolio of Swiss equities worth CHF 100,000 can be hedged against falling prices. A look at the stocks in the portfolio suggests that it should perform similarly to the Swiss Market Index ("SMI"), therefore the portfolio can be hedged with SMI Mini-Futures or Knock-Out Warrants. However, hedging can only ever be carried out approximately, as it is associated with costs and the correlation between the portfolio and the index is hardly 100% in practice.

For the sake of simplicity, we will limit the following example to portfolio hedging with SMI Mini-Shorts. However, the same method can also be used 1:1 for hedging with SMI Knock-Out Puts.

Portfolio hedging with SMI Mini-Shorts

By hedging with SMI Mini-Shorts the portfolio is "frozen" so to speak. Losses on the portfolio are offset by the increase in value of the SMI Mini-Shorts

1. Calculation of the required number of SMI Mini-Shorts:

The number of SMI Mini-Shorts required for hedging can be calculated using the following formula:

Number of SMI Mini-Shorts = (value of the portfolio / current index level) x ratio

(100'000 / 10'591) x 100 = 944 (rounded)

944 SMI Mini-Shorts are required for the hedge.

2. Selection of the product:

Please note that SMI Mini-Shorts / Knock-Out Puts have a stop-loss level. If the SMI touches this price level, the products expire and the hedge is no longer intact. The closer the stop-loss level is to the current level of the SMI, the lower is the cost for the individual SMI Mini-Short / Knock-Out Put and consequently for the overall hedging position. However, there is a risk that the hedging position will knock out very quickly. When selecting the SMI Mini-Shorts / Knock-Out Puts used for hedging, it's important to ensure that the stop-loss level is sufficiently far above the current SMI level.

For the further calculations, we use an SMI Mini-Short with a ratio of 100, whose financing level (FL) is 11,472.86 when the hedging transaction is entered into (initial situation). The following table shows how the value oft he SMI Mini-Short changes if the SMI quotes at 9,800 or 11,200 points after one month.

3. Possible scenarios after one month:

4. Conclusion:

By buying 944 SMI Mini-Shorts, the portfolio is hedged against price declines until the hedging position is sold again or the price of the SMI reaches the stop-loss level and the SMI Mini-Shorts knock out.

The difference between the total for the respective scenarios and the total of the initial situation corresponds to the accrued financing costs for the hedging period of one month.

Detailed information on the functionality of Mini-Futures and further examples of hedging can be found in our product brochure.

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