I spent all of Monday with my wife and kids riding out Tropical Storm Emily. If you live in Southwest Florida like I do, you probably did too – I hope your family and your property are safe.
Now this storm was nothing compared to last year’s historical Hurricane Hermine, which was the first one to make landfall in 11 years…
But there’s one key lesson from both.
And with an even worse “storm” brewing right now – one that will affect all of us no matter where we live…
It’s absolutely crucial that you take the next two minutes to read this.
Why You Need Protective Puts in Your Trading Arsenal
My family and I live in what we consider to be a type of paradise. The temperature is almost always nice, warm, and calm, and we have easy access to the water whenever we want to spend some time together on the boat.
But there are times when a tropical storm, or even hurricane, can hit us out of nowhere – like Tropical Storm Emily:
That’s why we always need to be prepared. We need to to have our water reserves full, our food supply stocked, and our insurances polices in place.
And the same is true when it comes to the financial markets…
Think of the bull market we’ve been in over the past several months (really, since Election Day) as like the weather down here in Florida. It’s wonderful, warm, and pleasant… but it can turn at the flip of a dime.
And as you know from Friday, some economists, fund managers, and even Wall Street are bracing for what has the potential to be a financial crisis.
Now no one truly knows exactly when this could happen and when the markets will correct from these historic highs. After all, they’ve been saying this ever since President Trump won the election. On top of that, it’s only deemed a “correction” when they experience a 10% pullback in the opposite direction. But it’s better to be prepared before it happens instead of watching, waiting, and hoping for the best when it does, which could cost you a lot of sleepless nights.
That’s why I’m talking about this now…
There’s an options strategy you can employ every single month that acts as “insurance” for your portfolio: the protective put. This is a risk management strategy designed to mitigate any unrealized losses (I like to think of it as the food and water supply you need to ride out a storm).
You can place a protective put on a single stock by buying Long-term Equity Anticipated Securities (LEAPs) at or near the stock price. If the value of your portfolio drops when the markets fall, you can then sell that put for a profit, which would reduce your cost basis. That way, you can still bring money into your account to offset any unrealized losses at the time the put is sold. And you can do this on any optionable stocks (stocks on which you can trade options).
The best part is, you can can buy protective put options on exchange traded funds (ETFs), like the SPDR S&P 500 ETF (SPY), too. So even if you don’t have any individual, or very few, stocks in your portfolio, you can still hedge by using puts on the indices.
You can also go to ETF-specific websites or work with your broker to find the ones that most closely mirror your portfolio of stock holdings and consider opening put positions on them. That way, your ETF puts are better tied to the stocks you own and are familiar with.
And remember…
This isn’t a cash flow strategy – it’s designed to offset your unrealized losses by providing the opportunity to sell the put when your account value drops. This is “insurance” for your portfolio so that you’re not stranded whenever the markets turn for the worse.
Be safe – and good trading,
Tom Gentile
