The majority of people wouldn’t risk driving without the knowledge that they are protected with auto insurance. Using that same principle, you should make sure you have a strategy in place to protect yourself from a potential stock market crash. And based on the current stock market risk, it may very well be a possibility.
It’s amazing how many retail investors and traders who are long on the market expect the six-year rally to continue unabated. However, we haven’t seen a market correction in excess of 10% for quite some time. Even a five-percent market adjustment would make some sense.
Now, don’t get me wrong; I still believe stocks will close the year higher. But, at the same time, it will not be as easy to make money as it was in the past under the Bernanke Fed-induced money flow.
The Simple Method to Protect Your Profits
Let’s say you have $500,000 in portfolio assets. This money is at risk in the event of a stock market correction. However, one way to protect against this is by simply lightening the load and taking profits. You can’t go wrong with this plan.
Another Strategy to Shield Against a Stock Market Crash
What strategy? I’m talking about some straightforward risk management to counter a stock market reversal that could leave you with dwindling gains.
Let’s face it; we have been spoiled by the past six years. However, if you went through the stock market crash of 1987 or the Internet implosion in 2000, you understand why you need to be proactive in your portfolio management.
As I said earlier, you can simply exit positions; that’s one way. But there’s another strategy used by professional managers that is simple to initiate.
I’m talking about the use of put options as a defensive maneuver against a potential stock market correction. Also known as a “protective hedge,” this tactic’s objective is to protect your gains against market erosion…and allow you to sleep better at night.
Buying a put option means you benefit when the market declines. For example, you can buy put options on large stock positions or on indices such as the DOW, S&P 500, Russell 2000, or NASDAQ. You can also buy sector indices in areas such as gold, oil, retail, or technology, among others.
Examples: How to Use Put Options
So, how can you use this strategy as part of your portfolio protection arsenal? As an example, if your investment holdings are skewed toward the technology sector, you can hedge via put options on the NASDAQ through the PowerShares QQQ Trust (NASDAQ/QQQ).
Chart courtesy of StockCharts.com
If you want to protect against a broader market decline, the SPDR S&P 500 ETF Trust (NYSEArca/SPY) would be the type of put you’d look at.
It’s advisable to take a look at the numerous ways in which you can protect your assets in the event of a major market event, including put options. Safety nets are good to have!