Buying Puts and Rolling Out Quarterly to Hedge Your Portfolio

Introduction

Following the articles about hedging your portfolio against corrections, I'd like to present the performance of buying at-the-money puts in 2014 and 2018 with and without rolling out on a quarterly basis. Buying long-term puts as part of a covered call writing portfolio (with complex strategies added to the portfolio in normal VIX environments) creates the ultimate protection in distressed periods.

2014

We choose the 2.5 year expiration period for the Russell 2000 ETF, resulting in the following picture. Based on an initial 25k investment, we have an opportunity to take profits along the way and re-load the position when the VIX is back to low/normal levels of 14%.

(Source: Option Generator Research)


If we decide to roll out quarterly (thereby renewing the number of contracts, expiration period and the strike price), our risk/reward profile is more favorable as we keep our long volatility exposure steady. As we witness frequent spikes in the VIX, there are opportunities to take profits on our hedge and re-invest them in long-term growth companies.

(Source: Option Generator Research)


2018

2018 proved to be an excellent year for investors who had long-term puts in place. They had an opportunity to re-invest the cash back into great companies when the VIX was high and the stock market near its bottom, allowing for attractive covered call writing trades as well!


Circled in red, I highlighted the points where partial profit-taking would have been appropriate. The yellow areas indicate where re-loading the position at a low to normal VIX level would have been favorable.

(Source: Option Generator Research)


Again, not rolling out quarterly is a costly mistake since it results in faster negative time decay and smaller long vega (volatility greek) exposure. Stated differently, the hedge itself becomes less significant.

(Source: Option Generator Research)

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