Schaeffer's Trading Floor Blog

Option Trading Tips for Anxious Investors

Expert tips, tricks, and strategies to protect your portfolio

by 9/28/2012 1:33 PM
Stocks quoted in this article:

At this stage in the global economic recovery, the daily financial headlines are about as sunny and upbeat as your average Edgar Allan Poe story. On any given day, investors might be panicking over the death of the euro, China's hard landing, the U.S. fiscal cliff, or -- that perennial standby -- political turmoil in the Middle East.

Here at Schaeffer's, we take a slightly more pragmatic view. As contrarians, we generally try to avoid following a panicked herd of retail traders over any kind of cliff (whether fiscal, figurative, or somewhere in between). That said, it's never a bad idea to hedge your bets against the worst-case scenario, especially if these cautionary measures help to keep your anxiety levels to a dull roar. After all, we're in this market, too -- and a tidal wave of panic-selling won't do anyone's 401(k) any favors.

Every week, Senior V.P. of Research Todd Salamone shares our Monday Morning Outlook, where he highlights the key technical levels and sentiment indicators that could influence the market's short-term direction. If you're looking for actionable ideas and timely trading tips to stay proactive in a wild market, be sure to check out Todd's commentary each week.

And in the meantime, here's a roundup of our best expert advice on volatility, the fine art of hedging, and all-around disaster-preparedness to gird your portfolio for the End of Days. (You know... just in case.)

Tip #1: Forget the "Bernanke put." Try some Apple (NASDAQ:AAPL) puts instead.

  • To lock in profits or limit losses on individual equity holdings, the protective put is a classic -- and for good reason. This hedging strategy curbs your downside risk for a minimal cash outlay, and it's simple enough for even the greenest of options rookies to execute.
  • Learn the nuts and bolts of protective put options.

Tip #2: Be your own one-man "plunge-protection team."

  • Taking the notion of the protective put one step further, you can hedge against a broader-market crash by purchasing puts on stock indexes. It's the hedging equivalent of one-stop shopping, but keep in mind this method works best if you're primarily invested in big-cap, low-beta blue chips.
  • Find out how to hedge your whole portfolio in one fell swoop.

  • A slightly more liquid alternative would be to buy put options on equity-based exchange-traded funds (ETFs). Depending upon the makeup of your portfolio, you may want to consider the very broad SPDR S&P 500 ETF (SPY), the tech-based PowerShares QQQ Trust (QQQ), the Consumer Discretionary Select Sector SPDR Fund (XLY) -- or any of the dozens of other sector-specific ETFs available on the market. In fact, as Todd Salamone explains, hedge funds frequently use ETF puts to shield against stock-related losses.
  • Take your cues from the big-money players and guard your stocks with ETF puts.

Tip #3: If it's already broke -- fix it!

  • So maybe you should have bought that protective put three months ago... but you didn't, and that stock you had such high hopes for got dragged lower by a widespread selling spree. What now? To repair your losses on a trade gone wrong, you can use call options as a retroactive Band-Aid.
  • Fix a broken trade with a call ratio spread.

Tip #4: Sometimes, a protective put is just too pedestrian...

  • Experienced options players don't have to limit themselves to straightforward put purchases. If you're looking to up your hedging game to the next level, why not flex your derivatives expertise by executing a put butterfly spread?
  • Check out this case study on a small-cap put fly.

Tip #5: ... but let the (spread) buyer beware when hedging with two legs.

  • Of course, there's a lot to be said for "keeping it simple, stupid" -- particularly if you're concerned the Four Horsemen of the Apocalypse may trot down Wall Street at any given moment. Our Founder and CEO, Bernie Schaeffer, explains how put-spread hedgers can inadvertently cut themselves off at the knees, all in the name of saving a few dimes' worth of premium.
  • Read this before you hedge your bets with a put spread.

Tip #6: Get comfortable with fear.

  • Or, more specifically, the "fear index, " which is formally known as the CBOE Market Volatility Index (VIX). Before you can begin to interpret VIX moves, you need to understand what it's measuring, how the index is calculated, and -- most importantly -- exactly what those VIX options are based on. (Hint: It's not the spot VIX.)
  • Start debunking those VIX myths right here.

Tip #7: Play the potential market crash with... call options?

Tip #8: Know the do's and don'ts of trading volatility.

  • Since the days of the 2008 market crash, the number of volatility-based trading vehicles has absolutely exploded. This may seem like a boon for retail traders, as there are now multiple ways to profit from the mushroom cloud of anxiety that seems to hit the market every other day or so. However, if you don't take the time to thoroughly understand these complex derivatives, betting on a volatility spike can be very risky business for the average investor.
  • Take a guided tour through the VIX complex before you trade.

So, there you have it. Whether or not the Mayans were right about this whole 2012 thing, you've got all of the tools and knowledge you need to build a metaphorical bunker around your portfolio. And now that you don't have to worry about panic-selling out of your stock holdings, there's plenty of time to catch up on all of those DVR'ed episodes of Doomsday Preppers you've been stockpiling.


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