Last week we talked about tactics you need to consider to survive in a bear market. One of the most important points made was to always have protection. In a bull market the need for insurance is not so important. Markets going straight up only require minimal protection as this will drag on performance. Of course, we often do not know we are in a certain market condition until after the fact, but often times we can determine it in the present based on the facts: price action, volume, indicators, sentiment and Fed activism.
The simplest and least costly protection would be to outright buy put options. Puts increase in value as a stock/index is falling. Since most of us are biased to hold positions that will rise with the market, these positions could take a substantial hit if the market corrects. This is a fraction of the cost for holding a short position in the underlying.
We have found in bear markets there are violent moves up and down, quick and painful. Just last month, five straight days of gaps up or down on the opening bell. To be positioned correctly would have been extremely lucky, but only relying on luck is no way to invest or trade.
Buying some index puts on SPY, IWM, QQQ or DIA is the easiest route to take, these are very liquid contracts. They will provide some shelter if the market pulls back sharply, the recent SPX 500 run is more than 10% up in just under a month. We are not trying to time a move here, rather just dampening the volatility of a long portfolio. If it doesn’t work exactly right, it could be considered smart and cheap insurance. We don’t like losing money, but when the market takes a whack we are happy to have the insurance in place.
