So what are you worried about? If you’re a Cub fan you’re worried all the time! That I can’t help you with because you should be worried. But how about your $300,000 stock portfolio? It’s been a nice run but now you’re thinking all good things got to come to an end. For example, let’s say you are worried about a 15% to 20% market decline in the next three months. Your goal should be to limit downside risk and keep your upside profit potential intact. Here’s how the protection works:
First you need to determine the number of SPX (S&P 500) Puts you will need for protection.
SPX @ 1560
Portfolio $Value to be Hedged / Notional Value of Index Contract (Strike x $100)
$300,000 / (1560 x $100) = 2 SPX Puts
Buy 2 SPX June 1560 Puts @ $41.00 ($4,100 per contract)
Total Cost = $8,200 (excluding commissions)
One SPX June 1560 Put protects $156,000
Assume in our example SPX @ 1248 Market is down 20% so portfolio is down 20% Your $291,800 stock portfolio is now $233,440
SPX @ 1248
1560 Puts @$312.00
Value of Puts: $312.00 x 2 x 100 = $62,400
Total Portfolio: $233,440 + $62,400 = $295,840
The market is down 20% and you are down less than 2% If you are unwilling to pay for Puts you may consider selling near-the-money calls on stocks that you are willing to sell now. You could sell out-of-the- money calls on stocks that you are willing to sell if the price rises. Or a Bear Put spread may be another consideration to off-set the purchase price of the puts to a certain degree.
There is an old saying in the pits here at CBOE. Buy Puts when you can, not when you have to.