We often talk about the need to protect ourselves against accidents, tragedies or disasters.  Insurance is that ‘necessary evil’, a sunk cost but often helps us sleep at night.  Imagine not having car insurance if you are in an accident, or health insurance if you are sick and need medical attention. 

When investing and trading, we can also buy insurance to protect our portfolios, and there are times when this is most prudent.  We can protect our portfolios in several ways, but for short term movements the best way is to buy put options or sell call options.  Of these two strategies I prefer to buy puts, as when uncertainty is high and fear levels increase we find put premium accelerating as markets decline. 

At some point, the markets will stop falling (we hope), but when we have protection it can certainly insulate our bullish plays against severe losses that are difficult to recover from.  Take the August drop, a devastating decline that happened in just days, and if you were unable to put on the protection via puts just before when the VIX was in the mid-teens, you missed your chance.  That area seems to be the best time to buy some puts, I prefer the indices:  SPY, QQQ, DIA or IWM, but some may prefer puts on individual stocks.

Recently, the stock market volatility flattened like a pancake, for whatever reason.  Buyers were rampant and falling over themselves to get long, but the VIX plunged down to 14%, a dangerous level of complacency.  Volatility buyers came out in earnest just before the jobs number was released on Nov 6, and buying insurance was prudent.  A week later the VIX soared to twenty, a 50% jump in volatility, and we can see the trend there had shifted upward.

Options provide some great protection and will often be far less expensive than you believe.  Even if they expire worthless or are sold for pennies, they provide the comfort to keep positions on and help cushion any blows for heavy selling that occurs quite frequently.