Hedging With Put Spreads, For The Red Times

My portfolio strategy is for the most part, autopilot. The only real time I have to make any adjustments is when the marketĀ (Dow Jones) moves in excess of about 500 points downwards. Hedging with put spreads is how I avoid getting destroyed in bear markets. In fact, you take a look at exactly what I am holding to hedge my account below on the right.

hedgeAs you can see, all of my put spreads will be at full value if the market remains steady or even goes up some. Currently, DIA (ETF index on Dow Jones) is trading around $147.50, well below these put spreads. Two of these put spreads were bought 3-4 weeks ago when the market was considerably higher, but they can act as fail safes for your portfolio for a time of crisis.

Note the numbers below ignore taxes and commissions.

  • My Oct 13 155/158 put spread, will be worth $3.00 and since I paid $1.35 per spread, it will net $2025 (81% gain)
  • My Sept 13 150/151 put spread, will be worth $1.00 and since I paid $.38 for it, it will net $1240 (163% gain).
  • My Sept 13 154/155 put spread, would also be worth $1.00 with a price tag of $.80 (purchased 8/21/13), it will net me $400 (25% gain).

In total, that’s $3,665 in loss mitigation.

But the problem becomes, although these put spreads become full value while the market tanks, they are limited in their potential. The solution of course is to sell them as they increase in value and re-buy at a lower put spread. Something that I have not done in the past few weeks, therefore leading to an almost 3% portfolio loss (still up a tad under 50% YTD). Expiration date is a component to selling and re-buying that you honestly become more familiar with only with practice.

So how much have these positions saved me during the recent downward slide? Well without them I would be down around 15% of my complete portfolio. This is why this component of my portfolio strategy is critical. If I was all long this year, sure I would be up maybe 100%+, but when the hammer falls, I would be massacred.

My idea always has been to make an easy to maintain portfolio that could profit in both upward and downward swings. Although I did not sell and re-write these put spreads, I am confident that I can obtain year in and year out returns in excess of 15%, hopefully in excess of 25% every single year, and we all know how scary big an account will grow at a rate of 25% yearly return.

You simply cannot call the market, don’t be naive, and be sure to hedge.


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