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Pocket Change & Look at Both Sides of a Hedge

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May 11, 2012 – Comments (0) | RELATED TICKERS: JPM

JPMorgan (JPM)

 

A $2 billion loss is pocket change or a drop in the proverbial bucket.  JPM spends more money buying back shares.

 

Don’t get too excited about looking at one side of a hedge.  And thinking oh my how could they do that.  A hedge needs to be looked at in context, both sides: the long and short. They need to be netted out. Looking at one-side makes it is easy to show a gain or loss.

 Here is an example of a hedge.  I will pick on the imaginary FOOL. 

You are long FOOL stock at 100, and the stock goes to $0.  The loss is 100%. That is a major hit.

But you hedged by buying FOOL put options with a strike price of $80 paying $10. Just in case the worst happened. It was your FOOL insurance policy.

 Let's look at the result:

Long FOOL stock at $100 now worth $0, or a loss of $100.

Long FOOL 80 Put, now worth $80, gain of $70 ($80 strike less $10 premium paid)

Net Loss $30

 What to fool folks?   

Talk up the gain on the put option and how $10 was turned into $80. Ignore the loss.

 Want to depress folks? 

 Talk about the loss on the stock and how the investment was wiped out. Ignore the gain.

 Want to impress folks? 

Talk about how the hedge helped turn a $100 loss into a $30 loss.

  

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