Trade Like a Hedge Fund - Protect Your Long Positions (QQQQ, SPY)

Today, as quiet and uneventful though it may have been, represents an amalgamation of the current trends in the U.S. equity markets. Investors are worried about: being underinvested, negative technicals, increased volatility, lack of volume, lackluster earnings an guidance, and government intervention. With all six of those points being highlighted in some way, shape, or form during the trading session, investors cannot be blamed for being confused with what to do with their hard earned investment dollars. For the Smart money and institutional traders, though, that is unacceptable. In this business, if you are stagnant—you’re going to get steam rolled. Note that the above statement does not mean that you cannot sit in cash — being in cash IS a decision; turning off the screen is not. With that said, investors and traders need to know that when the above conditions engulf the market, raising uncertainty along the way, institutional traders do one of two things: sell now and ask questions later or increase their levels of hedges/protection. While going out and buying a protective put on the SPY is by definition a hedge to a book of long positions, that is not nearly the smartest way to buy protection. Take a look at the following trade instead… Buy the Powershares QQQ Trust

September $43/41 1x2 put spread for a net credit of $0.03. Why is this trade a better way than simply outlaying cash for a put? 1. This doesn’t cost you one red cent. It is protection that gets put on in return for a bit of margin and the obligation to get a bit longer in the overall market should stocks fall 12.7% in a relatively short period of time. 2. The QQQQ’s track technology stocks, which are entirely more volatile than the S&P500; this gives you more protection per invested dollar than buying any type of protection on the SPY. The Beta of QQQQ is 1.11 versus the overall market’s beta of 1. Therefore, if you are looking for protection on $1000 of long positions, you only need to purchase 0.89 worth of Delta on the QQQQ. 3. The risk reward makes sense; you will start to make money on your long put immediately, whereas you do not start to lose any cash until the market falls 12.7%.