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The other day, I was talking to a student of mine about her stock portfolio. And let me tell you – it was looking pretty good.
I mean, why wouldn't it? All three indices are approaching record highs. We're in the middle of the biggest and longest bull market in history at 10 years, and my student is among many others who have been enjoying the healthy ride.
But here's the thing – historically, bull markets only last about five years. So we're overdue for a major correction…
It's time to prepare for the impending bear market. Because it could be even worse than the economic disasters that we saw in 2000 and 2008…
And there's only one way to make sure your portfolio won't fall victim…
Insure Your Stocks to Protect Your Portfolio from Another Recession
We're right in the thick of a 10-year bull market, and it could very well continue up from here…
But history tends to repeat itself. If anyone knows the truth behind that, it's us. Historical patterns are the basis on which we trade, after all.
A changing of the guard from the bulls to the bears is coming, and we need to be ready for it. Right now, many people are sitting on a lot of profit in their portfolios. So, how do we protect those profits?
Well, similar to houses, we can insure our stock "property" by buying puts. A put allows you to sell a stock at a specific strike price.
As an example, let's take a look at Walmart Inc. (NYSE: WMT)…
Walmart stock recently set an all-time high, so now would be a good time to consider protection. Right now, you could insure WMT at $110 until June 2020 (or even longer) by buying a June 2020 $110 put.
This put would give you the right to sell the stock for $110 at any time over the next year. In the event that WMT falls below $110, you could exercise your right – and sell it for $110.
So if it tanks to $50, it's no problem. With your put, you can still sell it for $110!
Sounds good… but it comes with a cost.
The WMT June 2020 $110 put will currently cost you $8.00 per share. To protect 100 shares (the minimum lot) of stock, that would run you $800.
In other words, you'd be spending $800 (7%) to protect $11,000 of stock for a year. If Walmart stock tanks, then that would be well worth it. But in the event that it continues to climb, your put will expire worthless in 12 months. Remember, it works exactly the same as a house or insurance.
After a year, your WMT insurance expires. To re-up, you'd pay another 7% for another year's worth of protection.
Now, that's all fine and dandy – but that's some expensive insurance.
Which brings me to my next point…
How to Insure Your Portfolio for Free
There is a way to protect your stocks without paying the 7% insurance fee. We can pay for our insurance by selling covered calls against our stock.
Here's how it works…
Buy ATM Put > Long Stock < Sell ATM Call
Selling an at-the-money (ATM) call gives you the obligation to sell your stock at the chosen strike price. Meanwhile, the ATM put gives you the right to sell your stock at the chosen strike.
Basically, you have the right and obligation to sell your stock at the current price. You have constructed a collar… a protective collar to be precise.
Here's an example…
We've already bought WMT January 2020 $110 puts for $8.00.
Currently, the WMT January 2020 $110 calls are selling for $9.30.
So, buying the $110 puts for $8 while also selling $110 calls for $9.30 yields a $1.30 CREDIT.That's right!
You get paid $1.30 per share ($130 for the minimum lot of 100 shares) to lock WMT in at $110 for a year.
Now, it's important to note that although you're protecting your downside, you are also giving up your upside.
If the stock drops, you'll be covered by your long puts at $100. If it goes up, you'll end up selling the stock at $110.
This makes sense if you don't want to sell your stock during a bear market.
With this strategy, you're ensuring that regardless of which way the market turns – bullish or bearish – you'll be protected.
But like I mentioned earlier… a changing of the guard from the bulls to the bears is coming, and we need to be more than ready for it.
It's more important than ever to not only insure our stocks with puts, but also to be using a system that can make us money when the market takes a turn.
Because we don't just want to be safe… we want to be thriving.
About the Author
Tom Gentile is one of the world's foremost authorities on stock, futures and options trading.
With more than 25 years' experience trading stocks, futures, and options, Tom's style of trading systems and strategies are designed to help individual investors propel themselves past 99 percent of the trading crowd.