Is it Time to Hedge GLD?

In a recent article, Tim Iacono, of Iacono Research, lamented that it was getting tough to be a gold bull. The good news for gold bulls who own it via the SPDR Gold Trust ETF (NYSEARCA:GLD) though is that it is very cheap to hedge now. In the past it wasn't uncommon to cost over 1% of an investor's position to optimally hedge GLD against a greater-than-20% drop over several months; today, an investor can hedge against a smaller drop -- a greater-than-10% decline - for even less. In this post, we'll look at two different ways to hedge GLD against a greater-than-10% decline.

The first way uses optimal puts*; this way has a cost, but allows uncapped upside. These are the optimal puts, as of Friday's close, for an investor looking to hedge 1,000 shares of GLD against a greater-than-10% drop between now and June 21:

As you can see in the screen capture above, the cost of those optimal puts, as a percentage of position, is only 0.77%.

A GLD investor interested in hedging against the same, greater-than-10% decline over the same time frame, but also willing to cap his potential upside at 10% over that time frame, could use the optimal collar** below to hedge instead.

As you can see at the bottom of the screen capture above, the net cost of this optimal collar is negative - that means that the GLD investor would be getting paid to hedge in this case.

*Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D to sort through and analyze all of the available puts for your stocks and ETFs, scanning for the optimal ones.

**Optimal collars are the ones that will give you the level of protection you want at the lowest net cost, while not limiting your potential upside by more than you specify. The algorithm to scan for optimal collars was developed in conjunction with a post-doctoral fellow in the financial engineering department at Princeton University.