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Portfolio Insurance

December 8, 2014

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As a trader I always think in terms of probabilities. What is more probable right now, in this time frame and I trade with that probability. It is for this reason and this reason alone I am slightly bearish on the market right now and short the RUT. If you trade in a 401k or an IRA you are most likely only long. This could be long stock, long mutual funds or ETFs but you are most certainly…long. This is a problem as there is more downside risk right now in the market. Lets work thru the problem with an analogy.

Lets say you own your own home and on our homes we pay insurance. If we were not forced to buy insurance monthly and there was zero risk of your house burning down, you would not buy insurance. There would be no need to. However, if tomorrow there was a 50/50 probability that your house would burn down and had the ability to buy insurance you definitely would. In the market, there is a 50/50 probability of your house/portfolio burning down. In this video I discuss adding insurance to the portfolio.

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5 Replies to “Portfolio Insurance”

  1. Denna Dean says:

    I took this advice and happily so last week :). Thank you for it because I got worried last week! It’s my first year of trading. Bought some 185 Dec14 SPY Puts. Now it’s worth half the value though. Do I sell this back? Do I treat it as traditional insurance and let it expire like worthless in order to keep the protection throughout the year? Maybe sell some Puts against to collect some income and offset my costs? What a good play to have happen now?
    Groovy,
    Denna Dean

  2. Hi Denna,

    If you’re trying to keep it simple – which is a good idea – then approach the puts as traditional insurance. If you’re looking to get creative then you can add legs either to turn the trade into a vertical or ratio spread. But that’s only if you know how that will effect your underlying risk and position.

    Cheers,

    Tim

  3. Denna Dean says:

    Well I have some covered call on right now that have now turned ITM with an Oct5 exp. If I’m assigned then I won’t any underlying risk. I know how to do a vertical and sell a put against it but I don’t know how to do a ratio spread. I’ll look that up. But since I haven’t paper traded the ratio spread I may keep it simple and let it expire worthless unless I have success paper trading one before it expires in Dec. Thank you!

  4. ZACCHEUSLLOYD says:

    I love the visuals: buying at the money protective puts, then seeing the risk graphs. Very important information, thanks for sharing!

    1. Glad you are enjoying them Zac!

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