Navigating market downturns using an options-based hedging strategy

Amid recent significant market volatility, Fidelity's Eric Granat notes that certain portfolio management tools could help dampen losses.

• In early April, capital markets experienced unprecedented turbulence as investors processed President Trump's shifting tariff plan. After announcing sweeping tariffs on April 2, the value of U.S. stocks eroded by trillions of dollars through April 8 — while also leading to intraday swings not seen since 2020, when COVID-19 upended global trading — before a surprise recovery on April 9 following news that tariffs for most countries would be paused for 90 days.
• The short-term decline was quite extreme and, while leverage isn't as stretched as in previous downturns, the unexpected scope of the move resulted in heightened volatility, leaving open the door for potentially more market shocks, according to Fidelity Portfolio Manager Eric Granat.
• Amid these uncertain times, an options-based strategy such as Fidelity Advisor^® Hedged Equity Fund or Fidelity^® Hedged Equity ETF could offer an attractive investment opportunity for defensively oriented investors, as it aims to provide a degree of downside protection during elevated market volatility — as well as upside participation — explains Granat, who has co-managed the fund with Zach Dewhirst since its inception in 2022.
• Case in point, he notes that while equities sold off sharply in the five trading days following the April 2 tariff announcement, our hedged-equity strategy performed as intended, reflecting a disciplined, options-based strategy designed to minimize downside capture — that is, offset or mitigate a decrease in the value of the fund's holdings amid market stress.
• "The rapid pace of buying equity put options, alongside a brisk equity sell-off, drove volatility to historic levels," says Granat. "Though major market moves like this can be unsettling for investors, this is precisely the market environment for which the fund was developed."
• He describes the fund as a defensive equity strategy that could serve as a core portfolio holding and may help reduce detrimental, emotional market-timing decisions.
• Granat and his co-managers primarily buy put options listed on the S&P 500^® index to act as a hedge for the respective holdings in the portfolio. The options purchased essentially seek to help offset or mitigate a decrease in value amid a strong and detrimental market downturn, without having to solely rely on diversification and tactical asset allocation.
• Notably, the fund aims to be more defensive than most of its competitors, seeking greater downside protection in the event of an even more extreme drop than what markets experienced in early April.
• "In essence, the fund is a tool to help hedge against market risk," Granat says. "Investors' reaction to the rollout of a confusing tariff policy was a significant exogenous shock that resulted in a spike in uncertainty and a rapid decline in equity prices. It is in these scenarios where an options-based hedging strategy can help to minimize the impact."
• Markets steadied following Trump's announcement of a 90-day tariff pause, but Granat notes that the outlook remains uncertain. For instance, it is not immediately clear which nations will receive tariff relief and/or how additional duties on China will pan out. Plus, he adds, other surprise announcements or news could easily spook markets once again.
• "I foresee a lot of changes investors will have to process," Granat concludes, noting that should the proposed tariffs be enacted, the U.S. could see tariff rates reach their highest point in about 100 years. "If the events of early April have proved anything, it is that markets will remain highly unpredictable until there is clarity, with possibly more downside volatility ahead."