There are so many reasons to be cautious: Persistently high interest rates, political uncertainty heading into November, geopolitical instability and a stock market that is trading at a premium valuation according to some. And Wednesday we’re looking ahead to unquestionably the most important earnings report of the first-quarter earnings season, Nvidia. Will the stock market correct lower heading into the back half of the year? Maybe. Will the breakout above the 2021/2022 highs continue and if so, are we still in the early stages of this bull market? Maybe. We can’t know the future and it’s a waste of energy to dwell on a fruitless exercise of trying to predict the future. Our job as active portfolio managers is to fully control the now and assess the current market environment. In this article I’m going to lay out a way to protect your portfolio using a put strategy should we reverse lower, thus leaving you in the position to benefit if this breakout is just getting started. Breaking down the market charts The S & P 500 broke out above the 2021 highs of 4,820 in the first two weeks of this year. The major question on the top of many investor’s minds is will we retest that level, but this time as support, which is a common occurrence in market behavior. Reinforcing this move back to 4,820 is a look at the mid-2023 decline that was about 11%. An 11% equal distance decline (another common occurrence in market behavior) from current levels projects a move to 4,725. Finally, a third factor at work is the uptrend support line in orange. There is a ton of support in this 4,820-4,700 zone. Will we retest that zone? Again, I don’t know. If we test that zone, will we hold support? I don’t know. And I’m content to come before you and say I don’t know and we can’t know. But what I can tell you is if we do go down to test that zone and we don’t hold support, then I am concerned. A way that I’m going to address this possibility that we don’t hold 4,700 support is to present to our clients an option to hedge a move to and through this zone. The market is incredibly quiet here on Nvidia earnings eve, which is very apparent by the low level of the CBOE Volatility Index . This measures how much premium is embedded in the at the money puts and calls in the S & P 500. The more expensive those options are, the more uncertain and fearful the market is. Right now, it seems many are quite content rendering the S & P options rather inexpensive as the VIX is testing the lowest level since just before the pandemic! An option spread I’m eyeing is in the S & P 500 (SPX) September 20 put options that buys the 5,000 strike put and sells the 4,500 strike put. The total cost of this is $29.50, or $2950 per spread. If on September 20, the S & P 500 is 15% lower trading at 4,500 (through our support level) the max profit on that spread is $47,050 ($50,000 spread – premium paid $2950). If you had a $1,000,000 portfolio facing a possible 15% drawdown your capital at risk is $150,000 assuming your portfolio correlated perfectly to the S & P 500. If we wanted to attempt to fully hedge a move to 4,500, we would buy three put spreads costing approximately $9,159, or 0.92% of your portfolio, offering a max potential reward of $141,500. If the market fell short of that 4,500 zone the reward on the put spread would be less than the max gain, but so would the drawdown in your underlying portfolio holdings. This gives us confidence to leave our holdings as they are to participate in what we think is an on-going bull market. But if we’re wrong and our crystal ball is clouded from either Nvidia’s earnings report, or any of the other factors hanging over the market’s head, we can minimize our portfolio drawdown. -Todd Gordon, founder of Inside Edge Capital, LLC DISCLOSURES: (Gordon does not yet own SPX options and for his wealth management company Inside Edge Capital Management, LLC. Charts shown are Optuma.) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
