Buying Puts for a potential crash?

[philpsw]

Purchase assets, apartment investment among other things!

 

[spindr0]

I need help using options to hedge against a huge market crash similar to the year 2000 or 2008.

What are your suggestions?

You asked about using $2,000 worth of puts per year to hedge a 400k portfolio. Asked and answered. You also asked for other suggestions so here's that two cents.

Long puts bought to protect appreciated stock is like car, home, health insurance. It's a total waste of money until you need it. In general, it costs about 6-8% a year to hedge with index puts. That amount may seem trivial this year as well as since 2009 but it's a lot of drag on a portfolio and in more normal times, it approaches long term annual market gains.

With your long puts, the maximum loss you could incur would be the from current price down to the strike price of the put (like a deductible) plus the premium cost. As with insurance, if you want a lower deductible, buy a higher strike price which means a higher premium cost (and vice versa)

I think that a more efficient way to protect individual stocks/ETFs is to collar them with their own options. That involves a willingness to sell the stock at a higher price. Do it on the securities that you feel are over valued or have run up too quickly. Sell an OTM call and use the proceeds to buy an OTM put for every 100 shares that you own. That defines a floor beneath which you cannot lose as well as a ceiling, beyond which you do not profit (unless you roll the calls up and/or out).

Collared long stock is equal to a covered call and a long put. A covered call is synthetically equal to a short put so if you make the substitutions, a collar is synthetically equal to a bullish vertical spread (floor and ceiling of P&L?)

Equity collars can be structured for no low/cost. If you want to skew the risk graph to having more upside than downside, sell a call further OTM - the collar will have a higher cost. Skew it in the opposite direction and it can be for a credit. Dividends with affect the collar's cost but since they affect option premiums, they're factored in.

Do shorter term collars (1-3 months, depending on distance from strike and implied volatility. With a short call strike that is reasonably far enough OTM, there's a decent chance that the stock will appreciate and not be taken away by assignment by expiry. If it expires, add later month's collar at higher strikes. Wash, rinse, repeat. If the underlying approaches the short call strike, you can roll the short call up and/or out. And if the market tanks, you can roll yiur collar's long puts down, booking option gains while remaining protected, though to a somewhat lesser degree).

Caveat? Don't monkey with collars if you absolutely don't want to sell the stock.

 

[truetype]

I am trying to figure the best way. Should I buy monthly puts, or every 3, 6 or 12 months?

Best to buy options matching the tenor of the risk you're concerned about -- apparently 2018 in your case. So Dec 2018 expiries.

 

[jimmyjazz]

Anybody know of collar studies showing expected performance? You can find them for buy/write (covered call) strategies, as well as ETFs for same. Obviously the short call reduces the drag created by the long put, but it caps gains, too.

 

[spindr0]

Google the "CBOE S&P 500 95-10 Collar Index" (CLL)

It's a three month SPX put 5% OTM and a one month SPX call 10% OTM. It does not perform well compared to their PUT, BXM and BXMD option writing indexes.

The CBOE has some papers describing these.

 

[jimmyjazz]

Great, thanks.

 

[spindr0]

OOPs, typo clean up time...

Google the "CBOE S&P 500 95-110 Collar Index" (CLL)

 

[tomorton]

Geez, this is a lot harder to describe than to just do. Hopefully this will make some sense.

A crash is different than a bear market. 1929 and 1987 were crashes. Unless you had some form of negative correlation protection in place prior to them, you took it on the chin. Bear markets like 2000 and 2008 took 18 months to unfold so they offered lots of time to react and adjust, namely transitioning to cash and if you have the experience and ability, shorting.

As to buying puts for protection as asked and ignoring more complex strategies, option premium is non linear so the cost per day is greatest for near term options and lowerfor far term options. Therefore, buying 3 month options four times a year will cost more on an annual basis than just buying a 12 month put.

OTOH, the protection level is fixed at the strike you buy so with a 12 month, you will not be protecting additional market gain if your portfolio value increases whereas with the 3 month options that cost more, you'll be stepping up your protection level every 3 months. The trade off here is cost versus degree of future protection.

I think that the only way to get a good feel for this is to see the numbers and that requires a little effort Set up a spreadsheet with the current value of the index you choose, say IWM and then "X" number of rows at lower prices at some increment you like Let's consider 12 month puts at 2.5 increments (if those strikes exist). IOW, with current price at 152.50, successive columns will be 150.00, 147.50, 145.00, down as far as you like. Determine how many puts you can buy at each strike with $2,000 and then assume that the market crashes and all puts are driven to parity. The rows will be the index price at lower levels. Determine protection gain below the each successful strike (# of puts times intrinsic value).

Do the same as above with 3 month puts ($500 spent) as well as 6 month puts ($1,000 spent).

Lastly, set up a spreadsheet with the value of your portfolio at 400k. If you used a 150p with the index at 152.50 then that is a 1.64% deductible before the puts kick in. Your loss will be 1.54% of your 400k plus the cost of the puts (assuming 100% correlation b/t portfolio and IWM). Do the same for other strikes.

If you wish, put all of this in one spreadsheet.

The short answer is that better protection costs more and has a lower deductible (loss of portfolio value). Poorer protection costs less but has a higher deductible. What you want to see is how well $2,000 protects you at different strikes as well as at different time periods (3, 6, 12 months). The answer may be acceptable. It may not be. The numbers will reveal hedge efficacy.

Clear as mud?

I don't see the value in making distinctions between crashes and bear markets, since they both look the same when a real-time decision is called for - hold or sell. Either way, the worst of both would have been avoided or siginificantly mitigated by selling equities if either -
a) Dow closes below 50EMA
or
b) Dow's 20EMA crosses below 50EMA

 

[spindr0]

I don't see the value in making distinctions between crashes and bear markets, since they both look the same when a real-time decision is called for - hold or sell.

Then you don't understand the difference between the two.

 

[tomorton]

Then you don't understand the difference between the two.

That is correct - at least up to a certain point in time as these things are just developing they look very similar. But what's more important is what to do about these things. How would you deal with one of the crashes you mention differently from one of the bear markets you mention?