Hedging Your 401k

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• Hedging Your 401(k)

Brian Cox 4/18/09
Nature is trying very hard to make us succeed,
but nature does not depend on us. We are not the
only experiment.  - R. Buckminster Fuller
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Protecting your 401(k)
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Protecting your 401(k)

• With many 401K plans you have the ability to
  select from mutual funds, stocks, bonds, money
  market investments or some mix from above.
• There is some nice reference information on
  Wikipedia at
• http//en.wikipedia.org/wiki/401(k)

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Protecting your 401(k)

• As you know, money is invested on a regular
  basis. The downside is that you do not have the
  flexibility of an individual trading account.
• Most of the instruments that you can select from
  are heavily correlated to market indexes

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Protecting your 401(k)
Dont you wish that you could keep your 401(k)
from turning into a 201(k)?
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Protecting your 401(k)

• While there is not much you can do with the your
  401(k) as the market drops but what if you were
  able to do offset the loss with something that
  goes up, as the 401(k) goes down?
• This is referred to as hedging.

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Protecting your 401(k)

• In finance, a hedge is a position established in
  one market in an attempt to offset exposure to
  the price risk of an equal but opposite
  obligation or position in another market.
• http//en.wikipedia.org/wiki/Hedge_(finance)

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Protecting your 401(k)
Self Directed IRA
401(k)
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Protecting your 401(k)
One way to create the hedge is to sell credit
spreads in your IRA account to offset the 401(k)
loss in value.
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Protecting your 401(k)
Don Kaufman (ThinkorSwim) instructor, suggested
selling vertical call spreads, within the 30-40
delta, every month. That way, if the 401(k) drops
or goes sideways, you are collecting income, if
the 401(k) rises significantly, the hedge gets
hit, but the 401(k) increases in value.
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Step 1 select equiv index/etf
First determine an equivalent index(s)/ETFs that
mimic youre the mutual funds in your 401(k).
Typical ETFs that are SPY, QQQQ, DIA, IWM. The
following slide shows that many mutual funds have
a beta close to 1 when compared to the SP 500.
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Step 1 (continued)
Most funds, despite their names will tend to
mimic existing indexes (SPX, DJI, Russell 2000,
NASDAQ. The above funds are closely correlated to
the SP 500 (beta close to 1)
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Step 2 calc equiv number of shares
Determine the equivalent number of shares that
the 401(k) represents. If the 401(k) total value
is 143,370 and it mimics the SPY (143.37), then
the equivalent shares is 143,370 / 143.37
1000 shares Convert it to number of
contracts 1000 / 10 100 contracts
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Step 3 execute trade
Execute the vertical call spread in the 30-40
delta range.
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Technique Step 3 execute trade (cont)
The monthly income is 3,500 to offset any drop
in value of the 401(k) that you are hedging.
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Technique Step 3 execute trade (cont)
As in all option trades, close out the trade 10-4
days before expiration and then execute the a new
spread for the following month. Rinse and repeat
every month
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Thinkback Calculation
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Summary
This method of hedging is not perfect. It wont
cover all losses in dramatic drops, but is can
offset some lesser loses and in many cases add to
the current net value, in a manner similar to the
covered call.