Two Ways to Stem a Bleeding Portfolio
We’re all worried about losing more money right now.
We’re all pining for the days of the past five years, where endless support from the Fed sent stock prices soaring day after day.
We’re all hoping the bear market will end soon.
But the reality is, hope is not a plan. The reality is, risks remain high. And acknowledging those risks is the first step to preserving your portfolio.
As just one example, the Consumer Price Index (CPI) was 0.1% higher than expected today.
This will give the Fed all the more reason to continue its rate-hiking campaign. As rates have risen, stocks have fallen. There’s no reason to think that dynamic will break anytime soon. On that merit alone, we should expect this bear to drag on for many more months.
And using history as a guide, we can get a good idea of how much further stocks will fall…
Even more importantly, it can show us how to deal with it.
Two Downside Targets for the S&P 500
We had a powerful bull market from 2009 to 2021. The S&P 500 Index gained more than 600% over that time.
This followed a nine-year bear market. (Yes, we were in a bear market from 2000 all the way through 2009. Stocks barely made a new high before reversing and falling further in 2008.)
And before that, we had an even longer 18-year bull market from 1982 to 2000 that gained almost 1,400%.
Take a look at the chart below. It shows how the nine-year bear retraced more than 50% of the bull market gains.
The current bear market has retraced just 30% of the bull market. If we saw a similar 50% retracement this time, that would put the S&P 500 all the way down at 2737, 22% lower from today.
Of course, history may not repeat exactly. Regardless, we are likely to fall below the 3220 level before the bear market ends. That would be a 38.2% retracement, or 8% lower from here.
That retracement level (38.2%) is one of the most widely followed prices in the market. It’s based on a Fibonacci number. Traders at large hedge funds follow these levels as a guide and we often see prices bounce at important Fib levels.
Given the downside risks projected here, setting up portfolio insurance against a bear market could be a wealth-saving move. There are many ways elite traders do this. And it’s critical to understand these methods before your portfolio bleeds out more.
Today, I’ll show you two possible ways to safeguard your capital from a plunging market…
Why Put Options Aren’t the Only Answer
Let’s start with portfolio insurance strategy #1, trading put options.
This is a pretty common way to insure a portfolio in a bear market. Puts increase in value when prices decline. But let’s see how well that will work for us right now.
The SPDR S&P 500 ETF (SPY) is trading at about $360 as I write this. As we established, our downside targets are 8% and 20% below that price.
I’m not the only one worried about a big decline. Based on options premiums, I can see that traders are preparing for a decline of 20% or more. Puts with an exercise price of $360 expiring December 30, 2022, cost about $19. That means the portfolio insurance is about 5% for three months. This is the price you’d have to pay to fully protect a portfolio against losses.
If SPY falls to $322 at expiration, the option will be worth $38 — a gain of about 100%. At $273, the puts would be worth $97, a gain of about 247%. But this only pays off if there’s a large move in the next three months.
If you ask me, that’s too expensive and probably not worth it. The problem is the bear market has already started. As you know, buying insurance after a crisis starts is costly. But you can still get good coverage if you find the right agent.
SPY puts are not the right agent. But this is…
Insurance Strategy #2: Trading an Inverse ETF
To get a better deal, we need to turn to the ProShares UltraShort S&P500 (SDS).
This is an ETF that goes up in price when SPY goes down. It’s designed to move twice as much as SPY every day. It’s up almost 50% this year while SPY is down about 23%.
We can buy calls on this ETF since these would benefit from the expected market decline. January 20, 2023, $50 calls cost about $7.50.
If SPY falls 10%, SDS should go up 20%. SDS would trade at about $67. The $54 calls would be worth at least $13, a gain of 73%.
This insurance pays off if there is a small decline in SPY. If SPY falls 20%, the calls gain 279%.
One SDS contract protects about $11,000 in your portfolio. That’s because this is a leveraged ETF and each 1% move in SPY should lead to a 2% move in SDS. This might be the most cost-effective way to insure a portfolio right now.
If you want to insure $100,000 worth of stock, just buy nine contracts. The premium is about 6.8% of the account value. This is still expensive, but the chance of a payoff is high.
Don’t forget, this strategy still comes with risks. It benefits from a crash. But the trade loses money if SPY goes up.
Overall, insurance is expensive. But if you believe the risks are high, then it’s worth it.
This is just a small taste of the many different ways we can trade options to level up our performance in a tough market. But it’s these kinds of tools that most average investors miss out on.
I teach all these different strategies at the New York Institute of Finance every year to Wall Street traders and financial professionals who fly in from all around the world. It costs almost $2K to attend my options course.
I realized how inaccessible this valuable information was to most, so I set out to change that.
My team and I just re-created that course in a digital format. It only costs $47, and it details every options strategy under the planet (in less than three hours).
You’ll get the same first-class options education like the pros without needing to leave your house. Better yet, you can take it on your own schedule.
Michael Carr, CMT, CFTeEditor, True Options Masters