Hedging with gold is one of the most classic moves in the financial playbook, and for good reason. It’s been a reliable store of value for centuries. And still to this day, gold is the universal hedge. Let’s take a look.
First let’s talk about inflation. Over time, we know that inflation can chip away at the value of your cash holdings. Every dollar buys a little less. But gold? Gold tends to maintain its purchasing power. When inflation heats up, people flock to gold because, well, it works. Maybe it’s a self-fulfilling prophecy; maybe there’s more to it. But it works.
Then there’s market volatility. In times of uncertainty—whether it’s due to geopolitical events or economic downturns—investors tend to run to the safety of gold. Why? Because gold doesn’t rely on earnings reports, dividends or the health of a corporation. It’s a hard asset with universal value.
On paper, it makes sense that gold has been a hedge since, well, forever ago. But is it the best hedge?
Well, not really. Take a look at this chart.
As you can see, at the beginning of April, yep, stocks went down. Gold went up. Then stocks started going up and, intuitively, gold went down. But look at the beginning of May. Both went up. Then at the end of May / beginning of June, both went down. And you can see how the rest played out. In theory, gold is a great hedge. In practice, only every once in a while does it work.
So what’s better?
How about puts? Well, yeah. There’s a tighter, more measurable relationship between a stock and its derivative product, options. We can measure the directional relationship with great precision using delta. Stock goes down by a dollar; 50-delta put goes up by 50 cents. If we want a direct hedge, we’d buy 2 50-delta puts (or 4 25-delta puts, etc.).
But the problem is time decay. The good old Greek, theta. If the hedge doesn’t work directionally–or even if it does–the puts lose value as time passes. It either doesn’t work as well as delta says it should because of theta, or it loses more than delta says it will, again, because of theta.
We don’t really even have to look at theta to tell that buying puts is a bum deal. These are the SPY near-the-money puts with 57 days till expiration. For less than 2 months’ protection, it costs you over 2% of the value of the underlying. Do that for a whole year and you lose more than the long-term average annual return.
How about a stop-loss order as a hedge? If the position goes against you, you close it. Well, to be fair, this is more position management than a hedge but kind of in the same vein. You don’t really need a hedge if you are managing your trades and investments properly, do you? So, yeah. A stop as a hedge. OK.
But…
There’s a problem.
Let’s look at one of the biggest risks we face as traders: overnight risk. I’d argue that the riskiest time for an options trader is between 4:00 PM ET and 9:30 AM ET. Why? Because our 24-hour news cycle can cause chaos, and there’s nothing we can do about it while the market is closed. Sure, it’s not an issue every day. But then again, needing a hedge is not an issue every day. It’s those big overnight gaps where you need protection.
So what’s the solution?
Don’t hold positions overnight.
Sounds kinda crazy. But actually it’s not. And I’m not the only person who thinks so. Not by a long shot.
Zero-day-to-expiration (0DTE) trading has become the most popular style of option trading there is these days. About half the volume in both the SPX and SPY consists of options that are put on “today” and expire at the end of “today.” The smart traders figured out the massive advantage to eliminating overnight risk.
Now you might be wondering: “But, Dan, what if my time horizon on the trade thesis is a week? Two weeks? A month? Two days?”
Great. Here’s what ya do… Put on the 0DTE trade today. Close it or let it expire today. And put on a new one tomorrow. And there are a ton of advantages to doing it this way as well.
First, if it’s an option-selling strategy, you get a much higher rate of time decay on the last day to expiration than longer-term ones. You make more money. Plus, as the stock price moves, tomorrow, you can pick different strikes on your trade. I think of this as the “dynamic strike price.” What a massive advantage it is to be able to “move the goal posts” when you want to on your credit spreads and such. Right?!
If you’re doing option buying strategies, sure, you might have higher theta. But when there are big moves against you, you don’t lose as much because you don’t have as much invested–you pay less because there’s less time premium. And you don’t have to carry the trade every day. The nature of the 0DTE trades “forces” you to manage the trade better.
On top of that, because 0DTE trades are so popular, they are the most liquid options to trade out there. Some traders are like you, putting on fresh 0DTE trades on expiration, and some are trying to close their trades. There’s just more trading volume, and that means tighter markets.
I’ve become a convert. Maybe the biggest evangelist for 0DTE trading out there. So next week, I’ll be hosting an online training on 0DTE trading and talking about a recent tool I created that helps me be able to trade them. Make sure you join us! You can register for that training HERE. I’ll see you online!
Trade smart,
Dan
Dan Passarelli
Founder and President
Market Taker Mentoring
