Brexit Vote FTSE100 Short Hedge Scenario Plan

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Regular Readers / Tweet Followers, will probably know I have some Huge FTSE100 Short Positions running which I put on earlier in the Year when Markets went quite ugly and caught everyone by surprise. Sadly my timing here was atrocious and Sods Law meant that the Markets rallied strongly since that malaise and this has been a real pain for me - it really was the worst possible scenario that could have played out.

Anyway, the whole logic of a Hedge is that if the Markets fall you are protected but if the Markets rise, then the gains on Long Positions should offset the Losses on the Short Positions - so in effect you are ‘Market Neutral’ - like going to Cash (I find this sort of Hedging quicker, easier, cheaper and more effective than selling Long Positions that I want to keep). This of course depends on the size of the Shorts and it is very hard (arguably impossible) to get it exactly right - if anything, experience tells me it is better to undersize the Shorts relative to the Longs. As it happens, my Shorts are probably a bit too big and when the Markets have risen for much of this year, my Longs have failed to offset the Losses on the Shorts - although it is noticeable that in recent weeks this has changed and my Longs are performing a lot better.

I have had an awful start to the year and my Portfolio is really not doing very well at all, however, I would only blame the FTSE100 Shorts for about a third of the overall Losses on the Portfolio - the far bigger culprit has been Profit Warnings on several of my really big Holdings like SPRP, TSTL, ETO and falls on Stocks like TTR for no particular reason.

When I put the Shorts on earlier in the year, it was really to protect myself from Downside Risk in the Markets but I had as part of the reasoning the view that this would be a very difficult year because we had the Brexit Vote on the 23rd June and later in the year there is the US Presidential Election where it looks like Trumpy could easily get elected - the Markets might really take fright at this. So my thinking was partly that if the Markets rose after the Sell-off at the start of the year, then I would get plenty of chances to unwind the Shorts later in the year before the Brexit Vote or perhaps in the Autumn, prior to the US Elections and when we usually get Sell-offs anyway. The beauty of Shorts at the moment is that Interest Rates are very low so it is not hugely expensive to let them run - although of course it would have been far preferable if I could have closed them earlier in the year. The raw fact is that Hedging for me is all about protecting my Portfolio from Downside Risk - funnily enough I have a Blog Draft in the pipeline which covers the subject of Downside Risk (and ways to avoid it) in depth, which should appear in coming weeks.

Anyway, we are where we are and all that, so I wanted to do a ‘Scenario Plan’ for how I handle my Shorts in the run-up to the Brexit Vote on June 23rd, which is about 3 weeks away now. To this end, below I have outlined some possible Scenarios and the Actions I can take. As a general point, doing this kind of planning can be a very useful exercise for all sorts of Investing/Trading Decisions and it can be most beneficial to think about these things in advance when you are calm and unruffled, rather than in the heated emotions of the thick of battle.

Scenario 1 - FTSE100 falls significantly prior to the Brexit Vote
This is my most preferred Scenario and probably the most likely. It is very hard to see Markets continuing to rise when the ‘Remain’ Campaign being run by the Established Government of the UK will be keeping up a constant drumbeat of negative Scare Stories if we were to leave the EU - this should scare Market Participants into selling Stocks and/or not Buying unless Prices are very low. This will in effect be a ‘Buyers Strike’ I expect where there will be very little ‘Buying Pressure’ but plenty of ‘Selling Pressure‘. In addition, June is the 2nd worst Month of the Year on average and the Summer is notoriously a poor time for Markets - it is hard to see the FTSE100 making much headway and there is a lot of Strong Resistance up above. On the other hand, the Markets have been surprisingly resilient and maybe they will do the unexpected - but I think this is very unlikely.

• Assume Markets will rally whatever the result of the Vote - ‘Leave’ or ‘Remain’. My thinking is that Markets hate Uncertainty and in the run-up to the Vote Markets will sell off on this Uncertainty but once the Vote has happened, the Markets will have some Certainty and will have to get on and deal with it. I reckon if there is a vote to ‘Leave’ then there will be a small Rally as there will still be many unknowns, but if there is a vote for ‘Remain’ then I expect a really big and sharp Rally (probably similar to when the Conservatives unexpectedly won the last General Election). However, the size of the Rally may depend on how close the two Campaigns are prior to the Vote - if Polls show things are very close, then Markets could sell off a lot beforehand (because the outcome is uncertain). If Polls give the Remain side a clear and easy win, then I would expect Markets to not sell off very much. In this Scenario, I would close my Short Positions a few Days before the Vote - obviously it will be important to try and gauge any FEAR in the Markets and use the Technicals like the Candlesticks and RSI (Relative Strength Index) to judge the Lows.
• Alternatively, rather than assuming there will be Rallies whatever the Result of the Vote, I might be better off taking a Judgement in the Days leading up to the Vote and reacting according to this. If it looks like ‘Remain’ will Win, then I should perhaps close all my Shorts. If it looks very close between the 2 Campaigns, then maybe I should close Half of the Shorts - this means that if the ‘Leave’ Campaign unexpectedly wins, then any Drop in the Markets will be ok by me as I will still have some sizeable Shorts in place to offset part of the Losses I will take on my Long Portfolio of Stocks. As with the situation above, it will be important to try and gauge any FEAR in the Markets and use the Technicals like the Candlesticks and RSI (Relative Strength Index) to judge the Lows.

The Approaches outlined in the Bullet Points above are unfortunately contradictory and this is a problem. The idea of a ‘Scenario Plan’ is that all the thinking is done up front and it is very precise and instructive so that the Emotional part of the Brain doesn’t get overly exercised at the time a Trading Decision needs to be made and it is more of a Robotic Task or following pre-determined Instructions. At the time of writing this Blog, I have not resolved this contradiction but it is critical that I decide the precise Bullet Point I will follow when we get into the Heat of Battle in the last week of the Vote. The second Bullet Point is imperfect because it is allowing for too much judgement - therefore I am leaning to just sticking to the Approach outlined in the first Bullet Point. 

To some extent any Decision will be affected by the degree of any Falls - if the Falls are big, then I would be more likely to Close out all of the Shorts (because a lot of FEAR and worry will be priced in); it the Falls are pretty meagre, then it might make sense to keep a bit of Insurance in case there are big falls after the Vote.

In the early days of June, if Markets start to sell off as I think is most likely, I will try to add more FTSE100 Shorts to take advantage and to raise my Average Price (opposite to ‘Averaging Down’ on Long Positions) - but I will use Stoplosses on any such new Shorts to avoid the problems of getting my Shorts over-sized if Markets continue to rise.

Scenario 2 - FTSE100 rises prior to the Brexit Vote
This would be my least desired Scenario - rising Markets will cause me a lot more pain and inconvenience. As mentioned in Scenario 1 above, I think it is very unlikely that Markets can rise leading up to the Brexit Vote - unless of course the ‘Remain’ Campaign with the Government and Davos Elites continue with their very effective Propaganda and scare the Masses into staying with an EU which is very much against their interests, and that this gets reflected into Polls in the days before the Vote in such a way that the Outcome is pretty much clear in advance to everyone.

• The logic of how Hedges work is that Gains I make on my Long Positions will offset the Losses I take on my FTSE100 Shorts - on this basis, it makes sense for me to keep the Shorts open. It would be a fair argument to say that I should close the Shorts and crystallize the Loss on them but my counter to this is that I expect to get plenty of opportunities later in 2016 to close them on Lows and there is a danger if I close the Shorts because I will then not have them on when Markets fall and I will not have protection. 
• If Markets continue to rise throughout the Summer, I will look for opportunities to put on additional Small Shorts to effectively raise my Average Price (the opposite of Averaging Down on Long Positions) but due to the risk of oversizing, I will use Stoplosses on these added Shorts. This will be particularly relevant as we reach September/October where Markets are notorious for big collapses - and with The Donald (Duck?) about to be US President, a fall could well occur.

Scenario 3 - Markets stay flat
This is very unlikely, but if it happens, then really the Actions for Scenario 2 where the Markets rise will apply.

Spreadbet Margin Requirements
Something else to bear in mind and to plan for is that Spreadbetting Companies may well change their Margin Deposit Requirements as we get near the Brexit Vote - this will particularly apply for both Long and Short Positions that remain open before and through the Brexit Vote on Thursday 23rd June 2016 (I understand that we may not know the Result until later in the Weekend). All Spreadbetting Firms will probably have their own Policies here, but I know that igIndex are going to double their Margin Requirement on Index Bets - so I will need to make sure I have plenty of Free Cash sloshing about in my Spreadbetting Account to cover any such changes.

On a related point, whatever Scenarios play out, it is a very good idea to make sure Cash Balances in Spreadbet Accounts are very high as we go into the Brexit Vote period - Markets could be extremely volatile.

Anyway, that’s given plenty to think about in the coming weeks, I need to sort that contradiction out that I discussed earlier and make a firm decision.

Cheers, WD


You can read my substantial Blog on Hedging here:

http://wheeliedealer.weebly.com/blog/topiary-time-aka-all-you-ever-wanted-to-know-about-hedging-but-were-afraid-to-ask

And this one on Why Prices move might be a useful read:

http://wheeliedealer.weebly.com/blog/why-do-share-prices-rise-and-fall