You work hard for your money. You ought to be able to keep it. No, I’m not talking about taxes, gas prices or your grocery store bill. I’m talking about investing your money in the market only to have less of it when it’s all said and done. This event, of course, is contrary to the investor’s plan. The whole idea of investing is to watch your nest egg grow, not shrink. So, what gives? If you lose money, are you doing something wrong? Is there a fundamental problem with your plan from the get go? Maybe the plan you have isn’t necessarily flawed; it’s just incomplete. Planning and ProtectionA typical long-term investment plan goes something like this:
Step 1 and 3 have an important element in common: you have complete control over them. Step 2, however, is a little different. You don’t have control over whether or not your money grows in the stock market. But you do have at least some control over whether or not you lose it. The following are 9 ways to try and protect your portfolio against losses when the market moves against you. 9 Ways to Protect Your Portfolio1. Diversify. Probably the most fundamental concept in investing is to spread your risk. In the big picture, this means investing in different asset classes—that is some stocks, some bonds, some cash, maybe some real estate or other investments. Within stocks, that means having exposure in several different industries. 2. Planning. Winging it just doesn’t work when it comes to investing. Know what can go wrong and be prepared for it. When it comes to portfolio protection, an ounce of prevention is worth a pound of cure. 3. Stop Orders. For active investors, something as simple as a stop order can help stymie losses on stocks, ETFs, options and more. Remember: Before you get in, know where you’re getting out for your winners and your losers. 4. Stay Current. An educated investor is our best customer. “Research” can be a stuffy old word. But it’s so easy and sometimes even fun in the information age. There are TV shows catering to investors like you that are both informative and entertaining. You can get market news online from blogs, webcasts, and RSS news feeds from your favorite sources. Spend some time (whatever you’re comfortable with) catching up on current events. 5. Option Education: An obvious way to protect an investment holding is with options. The problem, though, is that some people who use options for protection don’t understand them as well as they should. With options a little knowledge can be a dangerous thing. There are lots of options education organizations out there. Find one that works for you. 6. (Selectively) Buy Puts. The quintessential protective option strategy is to buy puts. But systematically buying puts against investment holdings can be a losing long-term strategy as option premiums add to the cost basis of the investment. You need to pick your spots with buying puts. 7. Buy Index Puts. What if you have a portfolio of many stocks and you want to hedge systemic risk? Do you need to buy puts on each stock? Maybe not. Correlating your portfolio to an optionable index like SPX, OEX, NDX, or others may enable you to “one-stop shop” when it comes to put buying. 8. Buying LEAPS® Calls as a Stock Substitute. Buying a LEAPS® call instead of stock can be a way to limit the initial cash outlay on an investment while still retaining upside potential. But investors holding LEAPS® call until expiration must see a big enough rise in the underlying to make up for the premium spent on the option. 9. Collar. Investors big and small can use this technique to truncate risk on an investment holding. With a collar, an investor can finance the cost of buying a put by selling a call. Here the investor has limited risk to the downside but limited profit potential on the upside. Further ReadingThe preceding nine ways mentioned to protect your portfolio each may be a viable technique depending on the market, your biases and risk tolerance, tax situation and other considerations. None of them are sure-fire ways to guarantee against losses. To be sure, they each deserve closer study before being put into action. Options involve risk and are not suitable for all investors. Before trading options, please read Characteristics and Risks of Standardized Option (ODD) which can be obtained from your broker; by emailing investorservices@theocc.com; or from The Options Clearing Corporation, 125 S. Franklin St., Suite 1200, Chicago, IL 60606. The content posted by our authors is intended to be general education and / or general information in nature. We are NOT providing advice for any individual trader. No statement made by our authors or subscribers is intended to be a recommendation or solicitation to buy or sell any security or to provide trading or investment advice. Traders and investors considering options should consult a professional tax advisor as to how taxes may affect the outcome of contemplated options transactions. Futures and forex trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing one's financial security or lifestyle. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results.You’re currently a free subscriber to Wealth Building with Options. For the full experience, upgrade your subscription.
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