How To Protect Your Portfolio From A Bear Market: PreMarket Prep Recap For Feb. 13, 2020

The U.S. stock market has largely ignored the spread of the coronavirus in China, but there’s no telling if, or when, that resilience will end.

For investors genuinely worried the market could significantly fall in the coming weeks or months if the virus doesn’t get contained, it may be time to consider some portfolio insurance. One way to do that is with options.

Playing The Options

Several weeks ago, PreMarket Prep co-host Dennis, who is worried about the contagion, bought SPDR S&P 500 ETF SPY Put Options to protect his investment portfolio from downside. Here’s how that works.

The puts Dennis bought were at-the-money, meaning the strike price was equal to the SPY's price at the time. In this case, it was $333. To buy the option, Dennis paid approximately $10.50 per share in premium, or about $1,050 for the entire contract (because one contract is equal to 100 shares). He bought 10 contracts, all of which expire in June.

In other words, Dennis paid about 3% up front ($10,050 is approximately 3% of what it would cost to buy 100 SPY shares) for four and a half months of protection. The idea is that should SPY fall below $333 before June, the put option will increase in value, allowing Dennis to profit against the theoretical losses in the rest of his portfolio.

Co-host Joel Elconin noted that buying puts is a better strategy for providing insurance than selling call options because it provides more downside protection.

"When you sell calls, let’s say you’re selling the $325 call in Apple for $4, you’re protected down to $321. But once the stock falls below $321 your protection is gone," he said.

"Exactly, the puts will protect me in the event that this turns into something big," said Dennis. "If you write those calls, you get $10 for them, you get 10 points of downside protection. If this really gets ugly, this could be a 20-30% fall in the markets. It could happen. I’m not saying it's going to happen, I’m saying it has the potential to happen.

"I am worried enough to pay 3% to protect my portfolio. And maybe it will expire worthless. Best-case scenario, there isn’t a contagion, my puts expire worthless, I’m still long all my stocks, and I go about my way just losing my 3%."

To see the full discussion on buying insurance for your portfolio, click here.

Other Stocks Discussed On The Show

Some of the stocks also discussed include, with technical levels provided by Co-Host Joel Elconin:

• American International Group IncAIG (click here)
• Tesla IncTSLA (click here)
• Sunpower CorporationSPWR (click here)
• Alibaba Group HoldingBABA (click here)
• Applied Materials, IncAMAT (click here)
• Cisco Systems, IncCSCO(click here)
• Tripadvisor IncTRIP (click here)
• MGM Resorts InternationalMGM(click here)

Featured Guests

Joe Saluzzi, Partner and Co-Founder of Themis Trading

Guest BioJoseph Saluzzi is partner, co-founder and co-head of equity trading of Themis Trading LLC, a leading independent agency brokerage firm that trades equities for institutional money managers and hedge funds. He is also the co-author of "Broken Markets -- How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence."

Joe’s full interview can be viewed at 32:40 in the video below or by clicking here.

Watch the full show or listen to the podcast below.

PreMarket Prep is a daily trading show hosted by prop trader Dennis Dick and former floor trader Joel Elconin. You can watch PreMarket Prep live every day from 8-9 a.m. ET here. The replay can be found on Benzinga's YouTube channel, and the podcast is on iTunes, Google Play, Soundcloud, Stitcher and Tunein.

Meet the Hosts:

Dennis Dick
Joel Elconin

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Disclaimer: All of the information, material, and/or content contained in this program is for informational purposes only. Investing in stocks, options, and futures is risky and not suitable for all investors. Please consult your own independent financial adviser before making any investment decisions.