The title of this blog post is a trick question. The answer, of course, is: It’s never time to sell index put protection.
Holding index puts is necessary for two main reasons:
Index puts mitigate risk
I’ve seen too many traders make the mistake of selling put protection at the exact wrong time. The markets are going up – why do I need to hold onto them? If you believe in Murphy’s Law, then you know that the precise moment you let go of your protection, the roof will cave in on you.
Now, we all understand that history is on the side of the bulls. Over a long period of time, the stock market goes higher. But we are not talking about making contrarian bets here. We just want to protect trades that could be vulnerable to downside action. Any stock is vulnerable at any time, especially in a stock picker’s market such as the one we are currently trading in.
Seasonal bullish trends tend to lull us into a state of lazy complacency. When most investors/traders expect the markets to move higher, why would you need to have puts working at all – especially if those puts hardly ever pay off? But much like homeowner’s insurance, puts can save you from expensive disasters.
And they lower the effects of volatility on your portfolio
Finally, puts are useful when market volatility starts to rise. Volatility does NOT necessarily mean markets are going down; rather, it means the current range is expanding. This makes investors/traders nervous, and they often choose to cut positions rather than stay the course. Thus a negative feedback loop begins – more volatility creates more uncertainty, raising the level of worry over further downward moves. But if you have puts in place? You’re ahead of the game.
In the end, always hold that put protection.
