As the fourth quarter gets underway, I thought it a good time to remind you to avoid complacency and buy index put protection. With a strong economy, low inflation, low interest rates, a strong dollar, solid earnings and indices near all-time highs, it’s easy to feel a bit comfortable. Don’t.
There are a host of issues tugging at the markets. The VIX is very low, the range of the lo/hi list is expanding (Nasdaq is the worst of them all), breadth has been miserable and breakouts have been few and far between. On top of this, past stock leaders have been weak, which opens up the possibility for some downside.
Just last week, the indices moved lower and we saw the biggest pullbacks since June. Is this something to worry about? Not yet, but these declines certainly lead to some nervousness.
The best way to calm your nerves is by adding some index put protection.
I often talk about how important it is to buy insurance for your mental, emotional and financial health. My go-to are index puts, like the SPY, DIA, QQQ or IWM. They don’t cost much, but you’ll be glad to have them when the markets get volatile. The last thing you want to do is buy protection when you really need it. Think about it this way: Would you buy homeowner’s insurance when your house is on fire?
Many people ask me how much to buy. That all depends on your risk tolerance, but my general advice is to have 3-5% of your portfolio invested in protective puts; continue rolling them forward. This is a very small amount, and it will drag down your total return. However, it’ll greatly reduce the overall volatility of your portfolio.