The insurance business can be a wonderful business. Insurance is the reason that Warren Buffett has turned Berkshire Hathaway (BRK.A) into the kingdom it has become today. In very basic terms, insurance is a product that people pay for with little likelihood that they will ever need it. Not all insurance is created equal. Homeowners insurance is a great insurance line, as is auto insurance. You may never get into a car accident or ever have a home damaged, but the amount you pay each year for the protection of insurance is a no-brainer.
Perhaps the same condition exists today with respect to the stock market. With the markets continuing to make new highs thanks to a stable economy and low interest rates, the inevitable correction looms closer. When that will be and how severe the decline, no one knows. But when markets are calm, that makes insurance cheap. The stock market has been rather calm over the past several months, so you would expect market insurance to be attractively priced.
Market insurance can come in various forms, but the most common and accessible is via put options. For those who are most pessimistic, options on the S&P 500 index via the SPDR S&P 500 (SPY) December 2018 put with a strike of $120 for around $3 per contract. With the SPY is trading at 215 today, this contract is for those who believe the S&P will fall by 50% or more over the next 26 months.
Even if the markets don't decline that much, if they do begin to experience a meaningful correction, which I view as 20% or more, even the above put option may become significantly more valuable depending on the time period remaining on the contract.
Perhaps more effective would be the December 2018 $175 put option, which can be bought for about $11 per contract. If the S&P were to fall more than 20%, it's likely this contract would increase in price measurably and provide a significant gain against what may be losses across a portfolio.
Stock market insurance can be a useful tool. Still, it's important to remember that insurance is designed to protect against significant loss. Otherwise the premiums are absorbed by the insurance provider. It's not that different with stock market insurance. The idea is allocate a small amount of funds that can be considered sunk costs if markets remain stable, but provide protection against catastrophe.