Tags: put | option | bear | sell

The Worst Ways to Prepare for a Market Crash

By    |   Friday, 27 Mar 2015 08:29 AM

Investors often worry about a stock market crash and some take action to avoid the expected decline. There are at least two ways to protect your net worth from a crash.

One way to avoid the bear market is to move to cash. This involves making two decisions. First you need to decide when to sell to avoid the crash and then you need to decide when to buy back into the market. Both decisions are difficult to make and the risks of a wrong decision are incredibly high. Selling too soon means missing out on gains. Buying after a decline is difficult to do emotionally and many investors miss out on the rebound.

Another way to protect your wealth is to use put options. Let's assume you have a $20,000 account and are willing to accept 10 percent risk. You can buy a put option on SPDR S&P 500 ETF (SPY) that expires in June with an exercise price of $189, about 10 percent below the current price of SPY. You would need to buy one put for each $20,000 in your account.

A put option gives you the right to sell the stock or ETF at the exercise price any time before the option expires. When you buy an option, risk is limited to the purchase price. When you sell an option the risk is unlimited. This is a limited risk, option-buying strategy.

The cost of the June put option is about $200, an amount equal to 1 percent of your $20,000 account value. If the market crashes, this put limits your loss to 10 percent of your account value.

If the market doesn't crash, you lose 1 percent of your account value on the put in three months. For a full year, this crash insurance is equal to 4 percent of your account. We have had two bear markets since 2000, one about every eight years. Maintaining constant protection against a crash would have been prohibitively expensive.

Rather than worrying about a bear market, investors should enjoy the bull markets when they develop. There are easy-to-follow strategies, like long-term moving averages, that will warn investors when a bear market begins. Following those strategies is less expensive and avoids large losses with less risk.

© 2017 Newsmax Finance. All rights reserved.

 
1Like our page
2Share
MichaelCarr
Investors often worry about a stock market crash and some take action to avoid the expected decline. There are at least two ways to protect your net worth from a crash.
put, option, bear, sell
376
2015-29-27
Friday, 27 Mar 2015 08:29 AM
Newsmax Inc.
 

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

NEWSMAX.COM
MONEYNEWS.COM
© Newsmax Media, Inc.
All Rights Reserved