3 Options to Hedge a Market Crash

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A lot of stock market pundits look at the market and shake their heads in disbelief. How is it that the market continues to rise to new highs?

ETF options stock market crash
Source: ©iStock.com/Kenishirotie

The economy is in terrible shape, first-quarter GDP came in at -1%, the Labor Force Participation Rate is at multidecade lows, the number of people on disability and food stamps are near record levels, and the national debt continues to swell

Some believe this bull market isn’t sustainable and a crash is coming. I can’t say if that will happen or not, and a long-term diversified portfolio is your best option in most cases. However, if you are worried about a market crash, you can hedge your bets via various option plays on some ETFs.

Market Crash Hedges – Guggenheim S&P 500 Equal Weight ETF (RSP)

Guggenheim185One broad-market ETF hedge for a market crash involves the Guggenheim S&P 500 Equal Weight ETF (RSP). This fund holds the various stocks of the S&P 500, but rather than being weighted by market capitalization, it’s equal-weighted, meaning each of the stocks has a much more equal effect on RSP than they actually do on the S&P 500.

By using an equal-weight ETF, you smooth out the volatility of the index better than if it were cap-weighted.

One choice is to swap out some of your large-cap individual holdings for this ETF so you aren’t exposed to wild swings in just a few stocks, and diversify more broadly.

Buy the ETF around the price as of this writing (currently near $76), then sell a Dec $77 call for $1.75. This will grant you a 2.3% return and provide you with a little downside protection if there’s a market crash.

You might step this strategy up by using some of the proceeds from the call to purchase a Dec $74 put for $3.20, or just buy the put outright without buying the underlying ETF. This will give you a six-month window during which, if there is a crash, a loss of more than 10% will translate into a profit for you.

Market Crash Hedges – iShares Russell Mid-Cap ETF (IWR)

isharesI would use the same strategy with the iShares Russell Mid-Cap ETF (IWR). Small- and midcap stocks tend to be more volatile than large caps, so you can hedge a large-cap portfolio more effectively by purchasing puts on a more volatile sector.

With this ETF trading near $160, consider purchasing the Aug $157 put for $7.40. That means you have a two-month window and if the index falls more than 7%, you are in the black.

In fact, in this case, you might want to purchase two puts. The first you sell if the market falls 10% to 15%, and the other if it falls more than 20%.

Market Crash Hedges – iShares US Technology ETF (IYW)

isharesTechnology stocks are perhaps the biggest movers in market crashes, as many tend to have high growth prospects, and growth always gets slammed in the big downside moves. The iShares US Technology ETF (IYW) has all the big-name tech stocks like Google (GOOG) and Apple (AAPL).

The ETF trades just south of $96, and I might consider buying two of the Sep $95 puts for $4.90, with a mind to sell one if the market falls 10% to 15%, and the other on a 20% decline.

As of this writing, Lawrence Meyers was long AAPL. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets at @ichabodscranium.


Article printed from InvestorPlace Media, https://investorplace.com/2014/06/options-hedge-market-crash-etfs/.

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