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Inspired by What is the relationship between taxes and annual liquidation of the markets?,

If a major fund wanted to sell off enough stock to significantly affect market prices, could they hedge the sale (eg. buy puts) to fix the price to prevent their portfolio from devaluing due to the sale?

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A broad based managed fund would be likely to distribute it selling across a variety of stocks, limiting the amount of downward pressure in any particular issue.

There are a number of ways to hedge, each having a different R/R spectrum. This is more in the purview of hedge funds than mutual funds. Put buying isn't that likely because it has a lot of portfolio drag, say 6-8% a year if hedging globally with large index ETF options (DIA, SPY, IWM) and costs even more if there's a sell off because implied volatility expands.

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  • Could you link me to descriptions of the strategies? I'm also curious about the put drag because that was how I thought hedging was usually done. Thanks! – ignorance Nov 13 '19 at 17:35
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    SPY is currently $309.31 and Nov 2020 $310 put is $20.57 so upside break even of this combo is $329.88. Effective cost is $19.88 since you're buying 69 cents intrinsic value. The cost of this hedge is 6.43% or 6.29% annualized. IMO, that's a lot of drag. SPY IV is currently near one year low. Last December it was more than double. If IV doubles, this put's cost will almost double. If in early, good for you since IV increase helps your long position. If you buy late (say IV has doubled), the amount of drag doubles (12+ pct is crazy high). Lucky timing is often everything. – Bob Baerker Nov 13 '19 at 18:39
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    Other hedges are covered calls, verticals, collars, pair trades (short another underlying) with differing cost and protection. I like low/no cost collars. If IV goes up, the short call offsets the long put so little to no IV penalty. Collar 1-3 months out. If underlying cooperates, roll the collar up and/or out, protecting some of your additional capital gain. Wash, rinse, repeat. If the market heads south, position loses but capital won’t be decimated. In a collapse, roll long puts down, lowering your cost basis. Caveat? Don't monkey with collars if you don't want to sell the stock. – Bob Baerker Nov 13 '19 at 18:39
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The market makers that "Sell to Open" the puts might hedge their position with sell-side futures or with the sale of highly-leveraged borrowed stock. So ultimately, the buying of long puts is selling pressure on the underlying. Also, there are position limits with options and futures. But the fund could increase its hedging.

It's a known problem that hedging is also selling pressure. Certainly, get into the hedge position before others pile-on.

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  • These days, except for illiquid stocks, option position limits on equities are massive, even more so for liquid ETFs like DIA and SPY. No idea what they are for futures. – Bob Baerker Nov 13 '19 at 1:42

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