Cash is Better Than Fat Tails Insurance

I fired off a quick email to a member who was thinking about implementing dynamic hedging:

I don’t think you should do dynamic hedging. If it didn’t work for Hayne Leland, Mark Rubinstein, and Taleb, it’s not something you want to deal with.
The point of hedging is simple: in theory, when a perfectly-calculated hedge is put on, the rate of return is supposed to be the risk free rate.
Say the value of the portfolio hits X, and this is your red line. You put on the hedge, all on, one time. From there, equities go down while bonds go up. You leave the hedge on as is but keep reweighting the long positions. The algorithm will automatically cut positions in equities and increase the bond allocation. So instead of risk free, you will get some additional juice from your net short position in equities and your net long position in bonds during the downtrend.

And if all else fails, there is always cash:
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