HOW TO PROTECT & HEDGE RETIREMENT PORTFOLIOS PT. 3
Commodities & Currency Hedging
Inverse ETFs & Fixed Income Hedging
We will show real-time examples of defensive options strategies new trades and investors can look in generating returns when markets selloff and protecting a basket of long-only stocks in retirement accounts. First, let's look at Alts-alternative strategies which typically can range on a wide spectrum.
What is the alternative asset class?
Alternative assets can be anything that has no direct and even inverse correlation to broader stock markets. Some of the more popular investments within this group can be classified as:
Direct lending/Credit (hard money loans)
and the list goes on...
Now I won't go into too much detail on each of these because quite honestly most retail everyday investors can't really invest in these asset classes due to regulations or the accredited investor rule defined by FINRA/SEC (regulators). Now investors can directly invest in these strategies through proxies which can range from:
Crowd Funding sites that invest in construction or development
ETF's that invest in hedge fund strategies and stocks that have a direct correlation to these asset classes like marijuana stocks. You can find these niche ETF's by visiting etfdb.com or watching the tutorial below on screening ETF's for investment.
When you have a few hundred thousand or only ten-thousand to invest this space wouldn't really appeal to you due to its limited capacity for entry. They do however show promise and over time with advancement in technology platforms allow for retail investors to further dip their toes in these markets as transparency becomes more prevalent.
Trading Options as a Defensive Strategy.
When investors both retail in institutional look to purchase insurance and protect portfolios they usually turn to the options markets. The reason being is it's easy to quantify what needs to be hedged and build a portfolio that could be classified as "risk-neutral".
If you're new to options trading lets first go over an elementary options introduction before diving into using more advanced options strategies to hedge out portfolios or make returns when markets selloff.
Traditionally, an “option” contract gives the holder the right to buy or sell an asset at a predetermined price within a certain period of time (or by an expiration date).
Note that the holder is not obligated to buy or sell at the predetermined price, he merely has the option to do so if he wishes to. That’s why they’re called options.
There are two kinds of options:
And for this brief overview, we’ll only quickly cover the mechanics of options buying.
What is a Call Option?
A CALL option allows an investor to BUY the underlying asset at a predetermined price, dubbed the “strike price.”
If an investor expects the underlying asset to rise above the strike price before the contract expires, he would purchase a call option.
What is a Put Option?
On the other hand, purchasing a PUT option gives the buyer the right to SELL an asset at their chosen strike price. So, if he thinks the market price of an asset will drop below the strike price before the contract expires, he would buy a put option.
The purchase price of an option is also called the “premium” and when buying options, the premium is the most you will risk or can possibly lose.
So the profit from an options trade is the amount the market has gone beyond the strike price minus the premium at the contract expiration.
For example, let’s say you want to buy a piece of land that is currently worth $100,000.
You think it will rise in value by another $30,000 one year from now, but you don’t want to tie up $100,000 for a year in that investment.
The seller of the land offers to sell an option contract to you to purchase the land for $100,000 (strike price) one year from now.
The seller offers the contract at a $5,000 premium. You agree, pay the $5,000 to the seller for the contract and wait to see if the value rises.
Let’s say in one year, the land value increases to $130,000. You decide to exercise your right to purchase the land at the agreed price (the strike), pay the owner the $100,000 contract price and now you own the land.
Your profit on the land is the current value, $130,000, minus the purchase price (strike) plus the contract premium: $130,000 – ($100,000 + $5,000) = $25,000.
Alternatively, let’s say that in one year, the land falls in value to $80,000. You are not obligated to exercise the contract and you obviously decided not to buy the land because it has fallen in value.
Your only loss is the premium paid ($5,000) to the option seller. As you can see, options are a great alternative to play your market ideas with very limited risk.
We put out a popular Youtube video that discusses how to grow small accounts and the basics of options trading which you can see below for further instruction.
Protective puts. The most basic defensive move allowing you to continue holding the stock is the long put, also called the "insurance" put. This is also termed a synthetic long call; in the event, the stock value rises, the overall stock/put long position rises as well. However, a problem with the protective put is that requires payment of the put premium. So if your basis in the stock is $50 per share and you buy a 50 put and pay a premium of 3 ($300), that means your net basis in stock has to rise to $53 per share. So you need a three-point gain just to break even. For this reason, just buying a protective put leaves a lot to be desired.
Synthetic short stock. The second strategy is to create an option-based position that will increase in value point-for-point if and when the stock's value falls. It consists of one long put and one short call opened at the same strike. The cost of the put is offset by the income from the call. This is a very low-risk position for two reasons. First, the net cost is zero or close to it and, in some instances, even creates a small net credit. Second, if you are trying to protect stock you own, each synthetic position provides protection for 100 shares. The put provides downside protection while the short call is covered. If the stock rises, the short call will be exercised; or, to avoid exercise, it can be rolled forward as an on-going covered call. This strategy solves the flaw of the protective put by covering the put's cost with premium from the short call.
Collars.The collar is very similar to synthetic short stock. It involves 100 shares of stock, a long put, and a short call. However, the call and put normally are opened at different strikes so that both are slightly out of the money. If the stock price rises, the call is covered; if the stock price falls, the put grows in value. And because the net cost of the two options is at or close to zero, it does not take very much movement for the long put to become profitable. Because the short call is out of the money, time value will fall rapidly as expiration approaches; so it is not difficult to avoid exercise by either closing the short call and taking a profit, or waiting for it to expire worthless.
There are many more methods for playing defensive with options; but as a starting point, every trader needs to be aware of these key strategies.
At Landshark Education, we focus on only trading a few ETF's and high momentum stocks both on the put and call side when markets sell-off. This ensures we don't have to spend countless hours screening various charts and finding setups. The most common way investors hedge their stock portfolios is to buy buying puts on major index ETF's like $SPY or $QQQ
If you're brand new to investing and trading but you want to learn how to trade options inside your portfolio for downside protection or income, then I highly recommend you register to our webinar below where one of our students will discuss how he made $50K trading inside his IRA using options. This will be educational and give you the tools necessary to become a DIY investor for your retirement accounts.
Register for $50,000 in 2-months: Student instructor shows how he traded options inside his retirement account.