Protecting Your Portfolio With Options: What’s The Best Way?

| October 3, 2014 | 0 Comments

protect portfolioJust a few weeks ago, the S&P 500 was up nearly 10% for the year.  Today, the benchmark index is up just about 6.5%, and investor concern is becoming more widespread.

When investors start worrying about a selloff, they often go to cash. But in many cases, it only makes the selloff worse.  Not to mention, if the market rallies, cash holders don’t get to take part.

That’s where hedging with options comes in.

Of course, like most things options-related, there are multiple ways to protect your portfolio from a major selloff.

The most straightforward method is to simply buy puts on whatever equities you’re holding in your portfolio.  As you’d expect, you’d be fully protected on the downside while still being able to take part in any upside action.

However, as accurate as this method is, it’s tedious and expensive.  There’s got to be an easier way to protect against downside risk without purchasing puts on every position, right?

Sure enough, you can get plenty of selloff protection by purchasing index puts.

The most common method to hedge with index options it by purchasing puts on an S&P 500 ETF.  The S&P 500 is the most widely followed market index and serves as an excellent proxy to most standard stock portfolios.

Keep in mind, it’s easy enough to alter the index put strategy if your portfolio varies from the S&P 500.  You could buy puts on the Russell 2000 index if you hold a bunch of small caps.  Or, you could buy Nasdaq 100 puts if you’re heavy on tech stocks.

Finally, there’s hedging with the VIX, which I write about frequently.  Buying calls on the VIX to protect against a spike in volatility has become as popular as buying S&P 500 puts.

In the event of a selloff, the VIX tends to spike. It often moves a lot faster and farther than the S&P 500 drops.  However, VIX calls do tend to be more expensive than S&P 500 puts.  And, the VIX will typically revert to its mean faster than the S&P 500 will recover.

So what method is best?

Let’s put it this way.  If you’re worried about a severe selloff, you’ll get more bang for your buck with VIX calls.  But, if you want to put on a cheaper, more conservative hedge, index puts are the way to go.

Either way, hedging your portfolio tends to be a wise choice in times of uncertainty.

Yours in Profit,

Gordon Lewis

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Category: Options Volatility Watch

About the Author ()

Gordon Lewis is the Chief Investment Strategist and editor for the popular daily newsletter – Options Trading Research. He’s also editor of our dynamic theme-based options trading service, Advanced Options Adviser, and one of the key analysts behind the highly successful Options Trading Wire.