Defensive Assets and How Should You Use It

To anybody who is seriously interested in defensive instruments, I highly recommend taking the time and studying in detail the questions listed below.

• First, let us speak about the beta coefficient. We need to realize that such tools as SDS (2x leveraged inverse S&P 500 ETF), DXD (inverse Dow Jones ETF) and, for example, SPXU (3x leveraged inverse S&P 500) have a negative beta coefficient. This is due to the fact that they move against the market, shorting it and leading at the same time. For example, the beta coefficient of SDS and DXD is -1, and SPXU is characterized by a -1.7 beta coefficient.

If we secure our portfolio through buying volatility, namely VXXB and TVIX, they have a positive beta coefficient value since for these tools, the index is the short-term total result of VIX index futures – a strategy index that maintains positions in the two closest monthly futures contracts of the CBOE volatility index (VIX), and in no way the S&P 500 or Dow Jones stock indices. In this case, the beta coefficient is 1 and 1.5 for VXXB and TVIX, respectively.

• Secondly (and, in my opinion, most importantly), we should stress the importance of the FUNCTION OF TIME when using these tools. By analogy with options (theta function), the time factor is also important here. These tools should not be kept in a portfolio for long or used as a long hedge. We need to try to get rid of them on time so as not to have hang-up adverse positions in our portfolio.

Here is an example. Suppose there is a decline in the market or there is going to be a correction. We are opening a long position in VXXB. For the period of time when the indices fall it provides an excellent hedge that compensates for our losses of positions in equities. Nevertheless, it is necessary to get rid of this protection on time because when the market direction changes, our defensive assets will incur our losses.

Keep in mind and memorize it! You should not keep defensive assets in your portfolio for long if you do not want them to work against you. Gold-mining stocks are excellent for the long run. First, they are not as volatile as reverse ETF, VXXB or TVIX. Secondly, they will give you an extra cash flow in the form of dividends.

You should not use insurance happy go lucky. It is necessary to monitor the market and make sure you study the material. All of my statements are of the utmost practical importance. In this case, time will either become your friend or your worst enemy.

Perhaps I’ve used gibberish, the language of an investment banker to write this text, so not everybody will understand all the aspects. Should you have any questions, you are free to ask me. But don’t forget the good old rule – “Study, study, study!” Whose words are these? I don’t even remember.

The article was written by Evgeny Kogan, Ph.D., investment banker, the author of the telegram-channel Bitkogan.