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Tales of a Technician: Put Protection is Cheap

November 19, 2019

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Tales of a Technician: Put Protection is Cheap

Volatility is dead and stocks are racking up record highs daily. In a world where everything is awesome why should I be a downer and plant the seed of protection in your mind?

I’ll tell you why.

Because I’ve seen this movie before and I know how it ends. It may not be fire and brimstone, but a correction is always looming somewhere on the horizon. Plus, the time to prepare is when it feels like you don’t need to.

And right now it feels like buying puts is the dumbest idea on the board. But that doesn’t mean it doesn’t have merit.

Let’s say you’ve been enjoying the market’s bullish march and want to lay some of your profits into some good old fashion put protection. Do you want to know how you can reduce the cost?

Do a bear put instead. Here’s how.

Puts, on the Cheap

The S&P 500 ETF (SPY) currently goes for $312. June 2020 options provide a good seven months of protection. And if we play with the 10% OTM strike of $281 the cost will only run us $6.58 which is just 2.1% of the price of 100 shares of SPY or the equivalent investment ($31,200) in a stock portfolio.

That sounds cheap to me. Chalk it up to the VIX flirting with 10.

But you can drop the cost even further if you don’t think the market will fall more than 30%. Said another way, if you’re willing to cap your protection once the market has crashed 30%, you can cut the cost by about $1.20.

Just sell the Jun $225 put against the $281 put that you’re buying. That creates a Jun $281/$225 bear put spread for a net debit of $5.38.

A Really Wide Bear Put

The most obvious drawback to using bear puts over long puts is that they cap your gains if a garden variety correction turns into a flesh-eating bear. Fortunately, those don’t happen very often. On the positive side, the lower cost of the bear put makes it an easier trade to enter than long puts.

Gino and I will be discussing buying put spreads in tonight’s Coaches Show. Join us for some additional insights. It’s going to be a blast!

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