[Options Bootcamp] Want Market Crash Insurance?
We continue our “Options Boot Camp” with the remainder of an interview with options expert Jim Fink. Today, Jim discusses how to use options as an “insurance policy” against a market crash.
Bob: Jim, given recent market turbulence many conservative investors are concerned about the possibility of another major market crash.
Is buying options a good strategy for protecting the value of a portfolio of stocks? What should interested investors look at? Are there strategies of selling options that protect you?
Jim: As we discussed yesterday, the advantage of selling covered calls is that they bring in cash up front. But the cash is a fixed amount. The additional income from covered calls provides a cushion against a modest stock price decline, but it doesn’t provide full protection against a market crash.
If you want real protection, buying a put option is like buying an insurance policy for a market decline. Remember, when you buy a put option on a stock, it allows you to lock in a specific selling price for a period of time. So even your stock drops like a rock, you can still sell at a higher price you’ve locked in.
It can be expensive, however, so you should look at ways to minimize the cost of this insurance. I won’t get into the full details here, but I have a number of easy to follow strategies you can use to insure yourself against losses at a pretty reasonable cost.
Bob: So let’s say I have a large position in Verizon. Am I better off insuring against a market correction by buying individual options on Verizon, or buying an option on the S&P 500 index or an ETF that includes Verizon?
Jim: The best way to insure against loss is to match your stock position as closely as possible. So in that case I would recommend buying individual put options on Verizon.
The risk of using puts on a related index is that they contain other stocks that may not be correlated with your long stock positions. It’s possible that even if Verizon were to decline, the indexes could rise in value (or fall much less than Verizon), leaving you with an inadequate form of insurance.
Bob: Okay, so let’s say I owned Verizon today at around $52. And I wanted to guarantee at least a $50 selling price regardless of what the market does. How would I do that?
Jim: It’s pretty simple really. If I wanted to protect myself from a crash in Verizon shares through May 20th of this year. I’d skim through a list of options and buy a put option with a $50 strike price expiring on May 20th. Then, it only takes one sentence of instructions if you were to read it to your broker over the phone (though it’s even easier to do it online).
“I’d like to buy to open the $50 put on VZ that expires in May 2016.”
To be clear, this isn’t an actual recommendation. In fact, right now I’m recommending some interesting trades to my paid subscribers that include puts, but in a totally different way. Instead of buying put options, I actually love to sell put options to generate extra income on a regular basis. It’s been a very successful strategy for me and my followers over the years.
Editor’s Note: Jim releases trades on a weekly basis inside his Options for Income service. They’re released each Thursday, and this morning he used an “options spread” strategy on a popular technology stock. He’s targeting a 53.8% gain over the next 30 days. To learn more about trading options with Jim Fink, click here.