Hedging Your Portfolio Is Vital!

| May 8, 2012 | 0 Comments

options traderUnfortunately my family just suffered a tragedy.  So, I took the last few trading days off to spend some well needed time with my wife and kids.

What’s even more unfortunate is that it happens to every family at one point or another.  And the last thing you need to worry about during these times is your portfolio.

Now, while I admit that I thought about trading some of my positions a couple of times over my time off, I didn’t spend a minute worrying about them.

The reason… option hedging and risk management.

As an options professional, I consider myself a relatively short-term trader.   Although it’s rare that I engage in true day trading, my holding periods usually vary from a few days to one month.

But over the last couple of days, I didn’t even turn on my computer.  There was no reason to waste the electricity.  Even when the market plummeted on Friday, I didn’t even break into a sweat when thinking about going back online to check my positions.

That’s one of the beauties of option hedging!

Although I enjoy the “thrill” of intraday trading, I’ve found that I’m better suited emotionally holding options for a longer period.  In addition to lowering stress, it allows me to take this much needed time off, something I’m slowly learning to do more and more.

It all comes down to this…

Having a properly protected portfolio allows me to sleep at night.

And right now, there’s no better time to revisit this theme… especially as we ponder whether this year will reinforce the adage of “sell in May and go away”.

The first key to protecting your portfolio is limiting leverage.

Most pros recommend that you have only 1% to 3% of your trading capital at risk in any one position.  Although, some are willing to go as high as 5% for really aggressive traders.

And for option traders, this is rarely a problem considering options are quite a bit less expensive.

Another way to protect your assets is through put options.

Protective puts are a great way to limit risk.

In addition, I’ve recommended in other articles, collar trades and covered call selling to hedge positions as well.

Any of these strategies are effective ways to hedge your portfolio and sleep better!

So, what do you think?

Hold on, the story isn’t over yet.

We need to address risk management…

This takes us to the next step.  The nice thing about using options is that it allows you to be bullish or bearish with equal simplicity.  Meaning, if you want to play a falling market, you don’t need to take the risk of shorting stock. You can simply buy put options.

And having this diverse mix of call and put positions allows you to further hedge your portfolio.

Lately, retail traders and investors have been turning to the volatility funds in increasing numbers to protect themselves.  However, these VIX-based products can raise serious issues, as Bloomberg noted in an article last week.

You see, the most basic fundamentals of risk management is don’t buy what you don’t understand.

You don’t buy a used car without looking at CarFax, and you don’t buy a house without an inspection. Likewise, you shouldn’t buy market products unless you’re well versed in how and why they work.

Bottom line…

While there’s no need to sell in May, hedging and risk management during this time allows you to withstand the current market gyrations.

Best of all, you can keep all of the money you’ve made in the first five months of the year safe and enjoy your summer!

Safe Trading,

Marcus Haber

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Category: Options Trading Basics

About the Author ()

Marcus Haber is the co-editor of Options Trading Research and boasts well over a decade of real-life options experience. Learning from some of the biggest names in the business, Marcus has served as an Options Strategist for a number of firms and was also appointed to the Options Advsiory Board with Pershing, a branch of the Bank of New York.