Funny you should resurrect this thread - I was analysing what I did back in 2008 and what would have been the best strategy for analogous reasons to yours. Whilst I dont think a meltdown is close in time, it does seem reasonable to think of strategies to plan for it in the medium to longer term. If only because there are profits which it would be painful to see vaporise if the market would take a real dive. The problem as always is timing what you want to do - last year in September/October I bought weekly or fortnightly at the money index puts for a 6 weeks or so. It was expensive but I slept better, of course the drop of the market early December17 is the one that actually hurt - the S&P actually dropped only marginally but the big winners of the year took a real step down and my portfolio was down 10% from 1st to 5th of December to get back to level at the end of the year (just for that month). I dont think S&P puts would have protected me adequately. On two individual positions that had appreciated considerably I tried two different approaches: - one is that I sold the DeepITM position and bought back at delta-equivalence ATM but with credit in net terms - the other I bought a collar (i.e. short the call and long the put for a slight credit) Of course the first position took a deep dive and the second continued appreciating. In both cases it would have been better to do nothing though in the first case the difference is marginal. Had I inverted the experiment both positions would have been better off than leaving things as they were. In any case my conclusion was that as a hedging strategy you have to be directionally individually right for those two tactics to work and its therefore hard to extrapolate this to something that could protect your portfolio. So my quest to prepare for a market downturn has turned back to index options. The fact you were long puts at the crash and still were out at the wrong time looks par for the course. As I am sure you realise from my musing I havent really got an ideal solution in mind. The one thing that strikes me is that the higher flyers tend to go down faster in case there is a setback so possibly there is some hedging or bearish strategy that could be built on that principle. Bear markets are as a rule shorter and more violent than bull markets so timing is everything but its generally the one thing that is impossible to determine with any certainty. Do you have view whether from money management and outcome it would have been feasible to hold on to a back-spread or call ratio spread back in 2008?
What got me with long puts was volatility contracting and time decay and the pending approach of the stage where that accelerates dramatically. With a ratio backspread I think it would depend on the size of the net debit built into the position from the strikes used for long and short side. I say net debit because playing around with an option pricing model indicates that for the position to be put on as a credit would mean a too large built in loss potential (nothing is free). If debit was small enough maybe you could hold knowing you were mostly covered from worthless expiration? Notye: I expect the market to possibly melt up ahead of any melt down. Hence the interest also in call spreads - catching some of the upside if melt up, limiting losses if goes down first.
The benefit of the 1 X 2 put spread is if you get it done for free it doesn't hurt your performance in a flat or up market. So if the market melts up it's clearly superior to a collar. Nobody really wants to do collars - they just don't want to pay for a put hedge. The clear disadvantage to the 1 X 2 put spread is you get twice the pain for small declines because your short the upper strike and the two lower don't kick in unless it's a big decline. Also nice is that if the market trends higher and you want to adjust - depending on what has happened with time, volatility and price(so everything) the roll up or up and out may not be too expensive.
ok so we have the following criteria (to be added to): - everything has a cost - we are willing to pay for the privilege of being bearish/insuring our portfolio but of course not more than necessary; - timing the market is impossible hence we must plan for time decay to impact our strategy and prevent it from forcing us out of our position at an inconvenient moment or for unacceptable cost; - normal market fluctuations (shall we say less than 5% down? Such corrections are quite common in a year and don't mean a bull trend is broken) should not lead us into losses. Our presumptions regarding the market is: - quite bullish for the shorter to medium term but with a perception that medium to longer term there will be a major drop (say 10% or more? This is an important criterion as it impacts pricing obviously and outcome); - volatility will contract as the market moves up impacting option prices; - we have a hypothetical 100,000$ portfolio to protect c.q. we are willing to be bearish for an equivalent value. So what strategy are we looking at? Strategy 1 - long term puts closer at the money because we expect sort term rise OS 4 P JAN19 SPY 280 @ 14.45 OB 8 P JAN 19 SPY 255 @ 7.35 MARGIN: 7500$ Strategy 2 - long term puts OTM (places the sold put somewhere between 2.5-5% lower than actual market) OS 4 P JAN19 SPY 265 @ 9.65 OB 8 P JAN19 SPY 240 @ 4.88 MARGIN: 7500$ Strategy 3 - long term puts deep OTM (black swan bet) OS 5 P JAN19 SPY 240 @ 4.88 OB 10 P JAN19 SPY 215 @ 2.48 MARGIN: 7500$ Strategy 4 - series of short term puts ATM (monthly - 12 times) OS 4 P FEB18 SPY 280 @ 3.63 OB 8 P FEB18 SPY 275 @ 1.68 MARGIN: 1500$ Strategy 5 - series of short term puts way OTM (monthly 12 times) OS 5 P FEB18 SPY 270 @ 0.89 OB 10 P FEB 19 SPY 260 @ 0.36 MARGIN: 3000$ I dont think it makes sense to have an intermediate level for the short term put strategy because that places you square in the middle of normal market corrections without time on your side to offset it. The first three strategies probably need refining in that we could consider rolling at 3-6-9-10 months. The shorter term puts run to expiration? Before we start running some numbers on that - any other strategy we should take into account and look at what if scenarios?