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> E.g. If I am net long in my portfolio and I fear some headwinds I can buy a put or two for the peace of mind. Now those puts should be always considered as wo

> E.g. If I am net long in my portfolio and I fear some headwinds I can buy a put or two for the peace of mind. Now those puts should be always considered as worthless, and it is just the price to pay for the peace of mind. Why don't you just change your allocation? If you can't sleep at night because of your current portfolio, and gyrations that are occurring, or that you are worried could occur, I would say it's obvious that it's not suited towards your risk profile. You're burning up some of the potential upside by spending money on the options, so why not simply take some money off the table instead and have a less complicated setup?

yreg 6y ago
Year ago when we were reading the news about what is happening in Wuhan, some of my friends bought SPY puts as an insurance against the potential crisis. The best outcome for them would be if those puts expired worthless. When you insure your house, you don't usually wish for it to burn down. I haven't acted and my portfolio took a -30% hit right after. Your suggestion (to change the portfolio allocation) would mean temporarily selling stocks and holding money. That strategy has an unlimited loss potential[0] if the stocks rise before you buy them back. With puts you are limited to whatever you pay for them. edit: [0] unlimited loss potential provided you want to keep the same stake at the companies
- sokoloff 6y ago
  I had SPY puts expiring in April at the same time, but as a hedge against Bernie Sanders doing unexpectedly well on Super Tuesday. He didn’t, but my timing was still good against a factor that I had been entirely ignoring.
- metafunctor 6y ago
  How does holding money have an "unlimited loss potential"? You just buy back at whatever value the stock is at the time. I would argue that money is a neutral position (adjusting for inflation which is nowadays quite low). After all, we buy stuff with money, not stock. Now, selling short, that has an unlimited loss potential, but it's very very different from a cash position.
  - mattmaroon 6y ago
    It’s unlimited because in the time he is holding cash there’s no limit to the amount the stock market could increase. If he sells a stock for $10, and then it goes from $10 to $10,000 he’ll only be able to buy back 1/1,000th of what he had. He lost $9,990. It’s the same as writing call options. There’s defined upside and unlimited downside.
    - gowld 6y ago
      By that theory everything has unlimited loss potential. "Loss potential" (downside risk) in finance refers to money you lose, not money you could have made by doing something else. https://www.investopedia.com/terms/d/downsiderisk.asp https://www.investopedia.com/terms/d/downsiderisk.asp
      - mattmaroon 6y ago
        Yeah I was just explaining what I was pretty sure he meant.
  - jmvoodoo 6y ago
    It's unlimited opportunity loss. If you sell at say $100 and it goes to $1000 while you're in cash, you "lost" $900 vs your original position. However if you hold at $100 and buy a put for $2 that hedges you, you can still participate in the upside while limiting your downside. Also, downside risk has been historically undervalued (this may be changing though) which is why tail risk funds exist.
    - metafunctor 6y ago
      Yeah, well, pfft. Not being on the market is an opportunity loss, sure. But it's not "unlimited".
      - yreg 6y ago
        The strategy forces you to time the market. You might get unlucky by holding cash during a market rally, then buy back for a dump. An investor who sells when they think the market is going to go downhill, with the intention to buy back later is not acting as an investor but as a trader. That's why hedging with options is less risky (and less profitable in the best case). edit: My use of word 'unlimited' applies if you want to keep the same stake at the companies. In money terms you cannot lose more than the value of your holdings.
- itsoktocry 6y ago
  >When you insure your house, you don't usually wish for it to burn down. You're leaving crucial information. You don't buy insurance (or puts) at any price. It has to make economic sense, and the person on the other side presumably has the same information.
  - yreg 6y ago
    Of course, being safer (more conservative) brings lower profits. I'm for sure not suggesting to be puts-insured all the time! It is just a useful instrument when one wants to hedge. The person on the other side is likely a market maker selling both kinds of options. The price is dictated by market.
- throw0101a 6y ago
  > Your suggestion (to change the portfolio allocation) would mean temporarily selling stocks and holding money. Or bonds: * https://awealthofcommonsense.com/2020/08/why-would-anyone-own-bonds-right-now/ https://awealthofcommonsense.com/2020/08/why-would-anyone-ow... Rebalancing is a thing, though generally for risk reasons. It would/could have saved one's returns during the so-called Lost Decade of the 2000s with the S&P 500: * https://www.forbes.com/sites/investor/2010/12/17/the-lost-decade-was-a-golden-age-if-you-rebalanced/ https://www.forbes.com/sites/investor/2010/12/17/the-lost-de... As your equities dropped, there's a good chance bonds would have at least stayed neutral, or even risen: so you'd sell some of those (sell high) and pick up equities at a discount (buy low). There are even products available that do this automatically for you: * https://investor.vanguard.com/mutual-funds/lifestrategy/ https://investor.vanguard.com/mutual-funds/lifestrategy/
johaugum 6y ago
> Why don't you just change your allocation? For one, altering allocations earlier may trigger short-term capital gains tax as opposed to long-term CGT. Hedging through options alleviates this.
JumpCrisscross 6y ago
> If you can't sleep at night because of your current portfolio You are correct. Buying options for peace of mind doesn’t make much sense. Buying them to e.g. avoid being short squeezed, protect against a margin call or insure against losses that will get you fired does.

yreg 6y ago

Year ago when we were reading the news about what is happening in Wuhan, some of my friends bought SPY puts as an insurance against the potential crisis. The best outcome for them would be if those puts expired worthless. When you insure your house, you don't usually wish for it to burn down. I haven't acted and my portfolio took a -30% hit right after. Your suggestion (to change the portfolio allocation) would mean temporarily selling stocks and holding money. That strategy has an unlimited loss potential[0] if the stocks rise before you buy them back. With puts you are limited to whatever you pay for them. edit: [0] unlimited loss potential provided you want to keep the same stake at the companies

sokoloff 6y ago
I had SPY puts expiring in April at the same time, but as a hedge against Bernie Sanders doing unexpectedly well on Super Tuesday. He didn’t, but my timing was still good against a factor that I had been entirely ignoring.
metafunctor 6y ago
How does holding money have an "unlimited loss potential"? You just buy back at whatever value the stock is at the time. I would argue that money is a neutral position (adjusting for inflation which is nowadays quite low). After all, we buy stuff with money, not stock. Now, selling short, that has an unlimited loss potential, but it's very very different from a cash position.
- mattmaroon 6y ago
  It’s unlimited because in the time he is holding cash there’s no limit to the amount the stock market could increase. If he sells a stock for $10, and then it goes from $10 to $10,000 he’ll only be able to buy back 1/1,000th of what he had. He lost $9,990. It’s the same as writing call options. There’s defined upside and unlimited downside.
  - gowld 6y ago
    By that theory everything has unlimited loss potential. "Loss potential" (downside risk) in finance refers to money you lose, not money you could have made by doing something else. https://www.investopedia.com/terms/d/downsiderisk.asp https://www.investopedia.com/terms/d/downsiderisk.asp
    - mattmaroon 6y ago
      Yeah I was just explaining what I was pretty sure he meant.
- jmvoodoo 6y ago
  It's unlimited opportunity loss. If you sell at say $100 and it goes to $1000 while you're in cash, you "lost" $900 vs your original position. However if you hold at $100 and buy a put for $2 that hedges you, you can still participate in the upside while limiting your downside. Also, downside risk has been historically undervalued (this may be changing though) which is why tail risk funds exist.
  - metafunctor 6y ago
    Yeah, well, pfft. Not being on the market is an opportunity loss, sure. But it's not "unlimited".
    - yreg 6y ago
      The strategy forces you to time the market. You might get unlucky by holding cash during a market rally, then buy back for a dump. An investor who sells when they think the market is going to go downhill, with the intention to buy back later is not acting as an investor but as a trader. That's why hedging with options is less risky (and less profitable in the best case). edit: My use of word 'unlimited' applies if you want to keep the same stake at the companies. In money terms you cannot lose more than the value of your holdings.
itsoktocry 6y ago
>When you insure your house, you don't usually wish for it to burn down. You're leaving crucial information. You don't buy insurance (or puts) at any price. It has to make economic sense, and the person on the other side presumably has the same information.
- yreg 6y ago
  Of course, being safer (more conservative) brings lower profits. I'm for sure not suggesting to be puts-insured all the time! It is just a useful instrument when one wants to hedge. The person on the other side is likely a market maker selling both kinds of options. The price is dictated by market.
throw0101a 6y ago
> Your suggestion (to change the portfolio allocation) would mean temporarily selling stocks and holding money. Or bonds: * https://awealthofcommonsense.com/2020/08/why-would-anyone-own-bonds-right-now/ https://awealthofcommonsense.com/2020/08/why-would-anyone-ow... Rebalancing is a thing, though generally for risk reasons. It would/could have saved one's returns during the so-called Lost Decade of the 2000s with the S&P 500: * https://www.forbes.com/sites/investor/2010/12/17/the-lost-decade-was-a-golden-age-if-you-rebalanced/ https://www.forbes.com/sites/investor/2010/12/17/the-lost-de... As your equities dropped, there's a good chance bonds would have at least stayed neutral, or even risen: so you'd sell some of those (sell high) and pick up equities at a discount (buy low). There are even products available that do this automatically for you: * https://investor.vanguard.com/mutual-funds/lifestrategy/ https://investor.vanguard.com/mutual-funds/lifestrategy/

johaugum 6y ago

> Why don't you just change your allocation? For one, altering allocations earlier may trigger short-term capital gains tax as opposed to long-term CGT. Hedging through options alleviates this.

JumpCrisscross 6y ago

> If you can't sleep at night because of your current portfolio You are correct. Buying options for peace of mind doesn’t make much sense. Buying them to e.g. avoid being short squeezed, protect against a margin call or insure against losses that will get you fired does.