Market Volatility Keeping You Up? – Hedge with Options

The Corona Trainwreck

Just a few months ago, many of the indexes fell by large percentages and many people were saying the market was potentially headed toward a recession or even depression. The sound for alarm was the Corona virus which many in the beginning just thought of as just another virus that would go away.

But, this was not just another virus and Corona virus hit the economy in a rough way and slowed down many industries just as the airline and hospitality industry. With the pandemic not looking to go away anytime soon, the market has since rebounded and hit all time highs even though the virus still rages on.

The market sure has been roaring higher

Many include myself wonder, how high can the market go? When will the next correction or crash be?

If you are somewhat concerned that the market is no longer valued correctly (which I believe the market is overvalued), you may be looking at ways to lower your risk when the next downturn happens. We all know that the stock market is cyclical and that with every upturn, there is also bound to be a downturn. The timing of when these cycles is the hardest to judge so you can use options to hedge.

Options

If you are not already familiar with options, they are a contract that essentially lets you bet on a stock moving up or down within a certain time frame. If you are looking for a more in depth explanation, Investopedia does a good job here.

With the current market edging higher by the day, you do not want to miss out on potential gains and I am still keeping my money in the market. But when the time for the market does come for a correction, I will be ready with my Put Options. By having put options, you are basically betting that a stock will go down and by using that strategy, you can essentially hedge against risk that you may feel is coming up soon.

For example, in my own portfolio I had put options after I heard the news that Corona Virus was spreading across China. I knew I did not want to sell my stocks as I am a long term investor, so by buying puts, I was able to hedge the risk and make some money back as the market plunged. Even though my stocks at the time decreased a lot in value, the options I had made money that could offset much of the losses at the time.

The thing to be wary though is that options do not always pan out. At the end of the day it is a contract where you are betting a stock will move a certain direction within a certain amount of time. I have had plenty of times where I thought the market was too high and that we were due for a correction, so I bought put options a few months out in case that were to happen and the market ended up going higher. But, options are just like they sound. They give you the option to act on them and if you let them expire because they are worthless, you just lose the premium that you paid on those options.

There are much more advanced strategies with options such as the iron corridor or butterfly spreads, but options can be used very simply as well as a hedging device. The choice is up to you whether you want to use them. If you are anything like me, I really enjoy holding stocks and if I do not have to sell and can use options to cover short term losses, well that’s what I am using.

Here’s to many more highs and more corrections, but be patient and you will be rewarded.

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