Hedging a portfolio by shorting index - Margin calculations

Question

I wish to run a long-only portfolio of stocks and hedge it during turbulent times by shorting a correlated index.

I'd rather short an index ETF for hedging instead of flattening my position. My assumptions behind this strategy are as follows:

1. If there are too many open positions, it will be more work to close and reopen them
2. I believe my long positions will outperform the index during a correction
3. I would rather not short individual stocks. Shorting index eliminates the risk of short squeeze, will always be ETB, and borrow fees will be low.

Coming to a concrete example:

Let's say that I fund a brokerage account with 100k in cash and turn on margin, which gives me 200k buying power.(For simplicity let's assume that it is a vanilla margin account as opposed to portfolio margin)

I buy 100k worth of tech stocks. I did not borrow anything to fund my longs. My buying power is 100k and maintenance margin requirement is say 25k.

At this point the market gets turbulent. Since my portfolio is all large cap tech, I short 100k worth of QQQ.

Questions:

1. Have I run afoul of my initial and maintenance margin requirements?

2. Is the hedging strategy sensible?

3. How beneficial would it be to turn on portfolio margin in this scenario?

Thanks!

Answer 1

Assuming that your broker allows Reg T margin limits then the margin requirement is 50% for each side (long and short). The minimum maintenance margin requirement is 25% for long positions and 30% for short positions. So you have not run afoul of either. What could be a subsequent problem is if a large component of your holdings were to suddenly have a significant change in either. For example, see 2008 where something like 900 financial stocks were banned from shorting for a few months.

Such a hedging strategy is quite sensible if you nail the correlation and if your strategy has an edge. Otherwise, no. If trading, you need a plan for dealing with both winners and losers as they arise (book gains and send in substitutes) - eg. reversion to the mean. If this is a long term investment strategy then not so much.

Make sure to use liquid ETFs that have low borrow costs for shorting.

Back test to see if there is long/short ratio that is more balanced (it may not be 1:1).

If trading, be willing to shift the long/short ratio intraday. IOW, be more long on an up day and more short on a down day, reverting to your overnight balanced ratio.

I ran a large long/short portfolio in 2008-2009 as well as in the 1/2 a dozen turbulent periods since then. Panic selling makes this concept more viable. For the rest of the time, not so much.

Can't help you with the portfolio margin since I have never used it.