Why Protecting Your Assets May Be Easier Than You Think
I hope you didn’t get caught off guard this past Monday with the broad market sell-off.
If you did, you need to really think about risk management and having a good investment strategy in place so that you can avoid or minimize the impact of a market correction.
And if you think that stocks will rally, don’t be so sure, because the current market climate is tricky and remains highly vulnerable to another correction, which, of course, could be much bigger.
You need to get rid of that invincibility feeling that’s probably stuck with you during the recent rally.
Success in trading and investing has nothing to do with bravery. Taking a risk to make big gains makes sense and has its place, but after the advance we had, you also need to be prudent and hedge your gains against the highly likely and bigger correction that’s still to come.
You need to have a viable investment strategy.
Taking some profits off the table makes sense, but you also need to protect your outstanding positions.
The sell-off on Monday indicates how nervous the market is, and don’t let anyone tell you otherwise.
So it’s an opportune time to remind you that you all need to hedge just like professional money managers.
My favorite investment strategy to protect gains is the use of put options as a defensive hedge against market weakness, or something that is called a protective put, or put hedge.
There is no special knowledge required. And it’s quite simple and easy to execute.
Think of this strategy as akin to buying insurance on your home, car, life, or other valuables. You wouldn’t be caught without insurance protection on your valuables, so why can’t you apply this to your stocks?
Under this investment strategy, investors may be bearish or uncertain and want to protect the current gains against additional downside moves in the stock or the market with the use of index put options on the DOW, S&P 500, or NASDAQ.
A logical investment strategy is to buy puts for stocks and/or sectors.
If you had exposure to gold, you could have protected yourself from the recent major sell-off that saw gold prices fall from above nearly $1,600 to below $1,400 in a few sessions. A good investment strategy would have been to buy put options on the Philadelphia Gold & Silver Index, which tracks 10 major gold and silver stocks.
And if your portfolio is heavily made up of technology, you can buy puts on the NASDAQ. For example, you can buy put options in PowerShares ETFs (NASDAQ/QQQ), a heavily traded put used for defensive purposes.
I hope the selling on Monday reminded you of the current vulnerability in the market.
The bottom line is that safety is the key to a good investment strategy, and having a put hedge makes sense.