Now, this is somewhat of a loaded question because there are numerous strategies that can effectively hedge a portfolio. But admittedly, I do have a few favorites.
For instance, if I want to hedge my portfolio over the short to intermediate term, I might use a variety of high-probability bear call spreads. The strategy allows me to define my risk and offers a low-cost way to place a few hedge-based trades.
However, for portfolios with higher capital I can take on a longer-term trade that has the potential to benefit from short, intermediate and longer-term moves.
The strategy is known as a poor man’s covered put . . . but I add a twist.
A poor man’s covered put is a neutral to bearish-leaning strategy which offers a wonderful way to add some short exposure to a portfolio.
It consists of buying one LEAPS put contract (going out roughly two years or more) and selling one short-term put (going out 30-45 days) against the LEAPS. However, to take full advantage of sharp down move I buy two LEAPS and sell one short-term put.
Let’s go through a basic position using the SPDR S&P 500 ETF (NYSE: SPY). You can use a cheaper priced ETF or stock if you wish, but I just want to go through the mechanics today so I’m using the stalwart ETF . . . SPY.
With SPY trading for $391.48, we can buy two January 20th 2023 470 LEAPS put contracts for roughly $95 or $9,500 per contract. Since we want to buy two put contracts, our initial outlay would be $19,000. Sounds like a lot, but normally our cost would be $78,296.
By purchasing two put contracts the delta of our LEAPS position is -.79*2 or -1.58.
Once we have our two LEAPS in our possession, we then can sell a put.
In this example, we sell the April 16th 2021 383 put contract with 30 days left until expiration. As seen below, we can sell the put contract for $4.95 or $495 per contract. The delta of selling the put contract is 0.35.
By selling the 383 put contract we are lowering our overall cost basis by 2.6% to $185.05 or $18,505.
Selling the short-term put every 30-45 days will allow us continually lower our cost basis while waiting for a decline to occur. If the decline never occurs and SPY remains flat to slightly higher, no big deal, we still have the ability to profit.
But the real money is made if SPY pushes lower because of the extra delta. Remember, we have the extra LEAPS put in our possession that will continually soak up profits if SPY moves lower.
Remember, the delta of our two LEAPS is -1.58 while the delta of our April 383 puts stands at 0.35. So, our overall delta is -1.23.
This means that we stand to make roughly $1.23 or 6.5% for every $1 decline in SPY . . . and that percentage accelerates as the underlying ETF continually moves lower.
And hey, if we want to sell two short-term puts from time to time, we have the ability to lower our cost basis even further. But please understand that you stand to make far less money if SPY pushes below your chosen short put strikes.
I plan on making a short video next week that goes through a few different examples to further elaborate how the strategy works. Stay tuned!