E Buying Umbrellas When It's Already Raining

Photo via Vivienne Gucwa

Buying Umbrellas When It's Sunny Out

In a TalkMarkets article last year ("Buying Umbrella's When It's Sunny Out"), I wrote about "buying umbrellas when it's sunny out" - that is, hedging when the market is up. The benefit of doing so is that it tends to be less expensive. The umbrella analogy came from the experience of walking in Manhattan during a rainstorm when peddlers try to sell you umbrellas for inflated prices. 

In that article, I showed the then-optimal put options on SPY to hedge against a greater-than-20% decline in the S&P 500, via the Portfolio Armor iPhone app: 

Optimal Puts to hedge against a >20% decline in SPY
over the next several months in April 2019.

As you can see above, the cost, as a percentage of position value, was 0.55%. I explained in the text of last year's article that that worked out to an annualized cost of 1.16% of position value. Let's look at how that cost compares to now, during the COVID-19 Crash. 

Buying Umbrellas When It's Already Raining

Let's say you decided to take advantage of last Friday's bounce to hedge against a >20% decline in SPY. In general, hedging on bounces is better than hedging on down days, but even Friday's bounce given the extreme volatility made hedging with optimal puts expensive, as you can see below. 

Optimal puts to hedge against a >20% decline in SPY
over the next several months, as of Friday's close.

One change we made to the app since last year's article, is it now shows both the cost as a percentage of position value (circled in red above), and the annualized cost as a percentage of position value (just below that). So, on Friday, the annualized cost of protecting against a >20% decline in SPY was 12.5%: that's nearly 10.8x as expensive as it was last April.

Wrapping Up 

The sun will come out again - there will be another bull market, and that will be a time to hedge against another market like this one. In my next article, I'll talk about an approach you can take to the current market. . 

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