2 instruments that come to my mind to hedge against stock market crash are options(buy puts) and futures (short index futures). Let me know if you know of others. Question to elitetraders here ... which instrument is your preferred one for hedging against stock market crash? What are the pros and cons of index futures vs options to hedge against stock market crash? My personal preference is futures because it's simpler. Simply get the direction right, good enough. After reading the thread below, it seems options are more complex and one can even lose money buying put options in a plunging market. https://www.elitetrader.com/et/thre...-money-buying-puts-during-covid-crash.356655/ What's your preference?
surely this question is very portfolio specific. Start by understanding what your benchmark is ie which index (or basket and index and weights) your folio is most correlated with, and look and buying OTM put options on the futures or ETFs tracking this basket. OR You can simply manage actively your portfolio (like I do) unhedsged, and rebalance daily by selling down to maintain a reasonable margin buffer.
The biggest problem with options is theta. So basically you not only have to be correct with the market direction, you also have to be correct with the magnitude of the crash. If it didn't crash enough, you can still lose. With futures, at least you don't have to worry about the erosion of value just due to time. But with futures, because it doesn't have theta, it's another full investment and if you are wrong with the market direction, you lose everything unlike with option, you only lose part of the cost. For me I still prefer to use options simply because I don't want to put in another full cost of buying another instrument and have to bear the brunt of the loss in case if I was correct in the market direction in the first place. And just to overcome the problem of theta, I would sell options to cover the cost and also long theta.
COST!!! Using deep-in-the-money options is super expensive and totally erodes profitability. Now you have the other problem, market direction. If the market didn't crash, you end up with zero or very little profit or worse, loss. And you still have to worry about theta, just less.
There's no perfect hedge- until 1987 there was 'portfolio insurance' . Best hedge against a stock market crash -try selling calls and buying puts-and getting the timing right!
Do you think shorting index futures is cheaper than buying deep-in-the-money index put options, assuming the account holder has a large capital?
I would say hedge in a different way, sell covered calls on your portfolio, or sell calls on indices instead. It has it's pros and cons. You get a limited insurance, so you are protected only to certain point, beyond that, your portfolio will get exposed. But in return, you stand to collect some premium if the market crash didn't happen or if a mild correction happened. If you do this correctly (in terms of ratios), you shouldn't be hurt if the market (And your portfolio) went up, since the losses on your short calls will be offset by the gains in your portfolio until the calls expire (But you will not be participating in the rally in terms of portfolio gains). I do this actually, I don't buy puts neither do I short futures, I just sell calls on positions, if I get called out, I can always go back in later and I manage to limit some of the downside (Not all of it usually, especially when the market decline is deep). Of course what I do might or might not suit large institutions managing large portfolios or funds, but that's how I deal with it.