RMI Applications: Tail Risk Hedging

Creating a Diversified TRH Suite

Each individual TRH technique has its own vulnerability, an “Achilles heel” of some sort.  You can think of that vulnerability as the price to be paid for cost-effectiveness.  As we have indicated, the key to managing the risk that these vulnerabilities present is to try to diversify them away by employing an array of independent TRH vehicles.

The graphs below illustrate the potential of one such TRH suite.  We have combined several of the individual techniques described above, and we show the impact of overlaying this suite on the S&P 500 Stock Index on a modeled pro forma basis.  As is evident, particularly from the log-scale version of the graph on the right, this TRH suite would have been successful in significantly mitigating the sudden equity market drawdowns in 2008/2009 as well as in the Fall of 2011, while having very low carrying cost during most all other periods when, in retrospect, protection was not needed.

It should be pointed out that combining this TRH approach — designed to manage the risk of market crashes — with the momentum-based sector rotation approach described in our prior piece — designed to manage the risk of sustained bear markets — represents a potentially very potent strategy to help protect portfolios from downside equity risks of all types.

In our next article, we will perform a broad review of other RMI strategies in the marketplace.

This article was written by the team at Giralda Advisors, a participant in the ETF Strategist Channel

[1] Technically, it is the result of solving the Black Scholes options pricing formula ”backwards,” for expected volatility, the one element of the formula that cannot be directly observed, using current market prices for options as inputs.


Disclosure Information

This material is for informational purposes only.  Nothing in this material is intended to constitute legal, tax, or investment advice.  Investing involves risk including potential loss of principal. 

Giralda Advisors, located in New York City, is an asset management firm that focuses on providing risk-managed exposure to the equity markets with a goal of limiting asset depreciation during both protracted and catastrophic market downturns while allowing substantial asset appreciation in up-trending markets.  The Giralda Advisors team welcomes your inquiries.  Call (212) 235-6801 or visit us at http://www.giraldaadvisors.com/