Stocks & Commodities V. 25:4 (44-47): Hedging Market Corrections Using SPY Puts by Matthew J. Stander
How do you protect your actively traded portfolio from the adverse effects of market corrections?
Most active traders are well aware of the impact that global macro economic events can have on individual
stocks. With the threat of rising energy prices, the Federal Reserve poised to fight inflation, a slowing housing market, monstrous levels of consumer debt, and pressure on the US dollar, there are plenty of reasons to be concerned. But at the same time, not participating in the market could mean missing substantial opportunities as these risk factors subside and good news emerges.
This leads to the question of how we can protect an actively traded portfolio from the adverse effects of a market correction. A bullish position on even the best stock can be negatively affected by an overall market correction.
One potentially powerful tool for protecting a portfolio against a significant market correction is a protective put on the SPY exchange traded fund (ETF). Buying put options on SPY, which tracks the Standard & Poor’s 500, can offer insurance against negative market moves and protect a portfolio. This article explains how to determine the potential sensitivity of a portfolio to market moves, how to calculate the number of puts needed to offset a correction, and how to decide which puts to purchase. Because it analyzes puts for their insurance value as a hedge against the SPY, we will only consider purchasing puts with strike prices below the current SPY price. Different types of analysis should be used when evaluating the purchase of puts with strike prices greater than the current SPY price (in-the-money puts).