The S&P 500 Put options have worked wonderfully over the past two weeks, protecting the portfolio from all losses and even providing some modest gains.
What a wild run it’s been! Over the last 2 weeks…
S&P 500: down 8.8%
Russell 2000: down 8.1%
TSX Composite Index: down 6.4%
My portfolio: up 2.0%
Over the last 2 weeks, not only did my portfolio not lose any money, I actually managed to report a modest gain. What gives?
If you look at my most recent portfolio snapshot, you can see the reason. It’s those SPY Put options that did the trick.
Hedging is an expensive business. You can buy insurance against a major market disaster in a variety of ways, none of which come cheap. For this reason, I usually stay away from these products. My philosophy is generally to be “all in, all the time”. I have consistently beaten the market by a wide margin in the past, so my reasoning is that it is better to be out there hunting for undervalued opportunities than it is to be sitting on the sidelines. However, with stock market valuations sitting at near record highs, this resolve has been tested. You can read some more about my concerns in the January 2018 Portfolio Review.
I finally gave in to my growing sense of dread back in November of last year and started accumulating put options on the S&P 500 (or rather, the ETF that tracks this index, which goes by the ticker symbol SPY). By January of this year, I was fully hedged, more or less, with a handful of put options that gave me the right to sell shares in the SPY index-tracking ETF at a price equivalent to 2900 on the S&P 500. These options expire Dec 21, 2018 so by the end of the year if the index closes much below this number, I stand to make money. If it closes above this level then my options expire worthless. According to my spreadsheet models, the options I bought should protect the portfolio from the worst of any coming market storm. However, theory and practice can be two very different things so I was very keen to see how my hedging strategy performed in this latest bout of market mayhem.
The options performed exactly as I expected them to, rising in value whenever the market dropped and perfectly offsetting the decline in the prices of my stocks. If anything, it seems I may have gone a tiny bit overboard with this insurance policy as my overall portfolio actually edged ahead over the past two weeks, thanks to significant gains on those put options (plus the relative resiliency of my stock holdings which dropped less than the overall market).
Of course, these options are a double-edged sword. While they should protect me from a significant drop in the markets this year, they will also significantly mute any gains I might make if the market decides to turn tail and resume its relentless push higher.
That is a big risk, and one that I do not take lightly. I will be watching corporate earnings very closely over the next 6 months as they come rolling in. Analysts are predicting phenomenal earnings growth this year in the order of 25 – 30%. If they are right, this kind of profit momentum could well drive stock prices to new, record highs. But from where I sit, I have difficulty seeing it.
For now, I am keeping an open mind, and enjoying the more relaxed perspective that my put options are giving me on this latest bout of market turmoil.