If the markets are rising up and showing no signs of slowing down, why would we need to own put protection? We have once again come to a time in the markets where we should be getting worried about a pullback. It could be significant or rather mild. Let's face it, any pullback after after rip-roaring rally will seem like it's the end of the world. For the SPX 500, a mild 3% drop would be about 100 points, and that'll feel awful.
To refresh, a put option accelerates in value as the underlying goes down. These move strongly when the drops are swift, sharp and painful for the bulls. Puts tend to work very nicely when the market is in a panic, but getting in early can be tricky.
But what can we do to blunt the force of a market pullback? We talk about buying put options quite often, and that it would reduce the amount of short term volatility in your portfolio. With a VIX currently under 12%, the market is not expecting wide moves. In fact, less than 1% moves are expected over the next month. Further, we have seen realized volatility slip to about 5% or less, so basically market volatility is not fluctuating.
Does that mean a big move is on the horizon? Not necessarily, but certainly anything is possible. We saw a similar situation in early May with markets at all time highs with solid technical and sentiment indicators, but some tweets about tariffs whipped the markets into a frenzy. The VIX rose smartly, over 100% in just a few short days.
So, what can you do to protect yourself? Buy some put protection as insurance. This is the same process as buying health, auto, home, or life insurance. In case of disaster you want to be covered. While many may believe it is not important to carry, I can attest that is not true. In fact, some of the best moves are made when sentiment is at extremes, like it is RIGHT NOW.
What is the game plan? Let's keep it simple here. Just add some at the money puts on the indices. My favorites include the (SPY) , (QQQ) , (DIA) and (IWM) . These are liquid vehicles that are priced fairly. Since volatility is low the price of options are cheap. One could buy at the money puts maybe two weeks out for a fraction of the cost to short the underlying. And, if the trend continues and the puts lose value - you just sell them and open some new put strikes later on. Rinse and repeat. It'll help you sleep better at night!