In major cities at this time of year, an army of street vendors bristling with umbrellas await their chance to emerge in entrepreneurial fervour, providing tourists and commuters alike with immediate respite from unanticipated rain. It’s a viable business strategy: the chaotic nature of weather means that occasional rainfall remains practically impossible to predict*, hence our common tendency to rely on an adaptive strategy. Demand and cost rises with tempestuous environments, while the inconvenience of preparing for the worst is a frustrating drag in sunnier times.
So does the same strategy of purchasing protection “as needed” work in the stock market? And does it cost more to do so? Stretching the analogy somewhat, we’ll look at three simple strategies to mitigate equity risk, and explain a little more behind the three indices shown below, each of which incorporates a different way to hedge an investment in the S&P 500® Index dynamically:
Source: S&P Dow Jones Indices. Total returns shown for the five year period to October 18th, 2013. Charts and graphs are provided for illustrative purposes. Past performance is no guarantee of future results.