about 1 month ago • 3 mins
Here’s some good news for anyone who likes a little added protection against risk: the cost of safeguarding your portfolio against a drop in the S&P 500 has rarely been this cheap. So if you own lots of stocks and want to cushion yourself against a correction, here are two ways to take advantage.
The put spread strategy. Imagine you’re buying an insurance policy for your investments. A put option is like that insurance, paying off if the market falls below the option’s agreed-upon price level, or “strike price”. But, just like insurance, it costs money. To make it cheaper, you can use a “put spread”, buying a put option (your safety net) near today’s market price and selling another with a lower strike price. The sale helps pay for your first option, making your insurance cheaper. If the market drops a little, you win. If it crashes, you still win – just not as much as you would if you had just bought a single put option, since the option you sold would have also cost you money. If the market rises, you lose just the small premium you paid for that structure. So that’s a great strategy if you’re betting on a normal correction, but not a total nosedive.
The collar strategy. Think of this like putting a collar around your assets, capping your gains and losses. In this method, you also buy a put option (the insurance against a market fall), but you sell a “call option” to pay for it. Like before, it’s a way of reducing the cost of that insurance. But unlike in the previous example, your gains here won’t be limited in the case of a market fall. And that makes this a better strategy if you expect a bigger crash. This strategy comes with a catch, however: if the market climbs high instead of falling, you might face a nasty bill because of the call option you sold. But, if you own the actual stocks, your losses from the options could be offset by your shares’ gains.
Of course, the best part is that these strategies are going so cheap right now. The price of a 98%/93% three-month put spread on the S&P 500 (dark blue line) is just 3%. That’s near its lowest price ever (it tops 8% when the market’s stressed). Now, this is shown in annualized terms, so you’d pay about 0.75% for three months. So if you own the underlying stocks, you could protect a $100,000 portfolio against a drop of between 2% and 7% for a mere $750.
For a longer-term strategy, consider the one-year 95%/115% collar on the S&P 500 (light blue), which at 2% is cheaper than it’s been since 2008. For $2,000, you could fully protect a $100,000 portfolio against a fall of more than 5%. Mind you, it’d also mean that you’d limit your gains to a maximum of 15% over the next 12 months. But if you’re risk-averse, that kind of protection might help you sleep better at night.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.