Insure against stock market crash

How can I insure against losses?

The best “insurance” strategy is to (1) buy and hold while (2) diversifying your assets. This means to buy a wide range of assets representative of the whole range of the economy, both foreign and domestic, and to not buy and sell as individual stocks do well but to avoid fees by just holding the stocks for the long haul. This helps to insure against the risk that a particular company, country, or asset class does badly. However, it has limits: what happens if the entire economy does badly, like during a recession?

One option is to buy a “put option”. Buying a put means you are entering a contract with another investor or firm that says that you have the right to sell them a particular asset on a particular future date at a pre-set price. So if you buy an Apple share at $700, you can buy a put at $600 for a particular future date and this means that, if Apple drops to $400 that you can still recover most of your money by reselling it at $600. Quite a valuable option, just in case–especially because you can buy puts for broad and diverse assets like a stock market ETF ensuring that you are insured against broad market losses. A good deal!

Of course, like normal insurance, you have to pay a premium for this option–even if you never exercise it. If you buy the $600 Apple put but the stock price just keeps going up, you’ll never exercise your option and you’ll be out however much you paid in the first place. Still, to buy that peace of mind just might be worth it.

So on the whole, the answer to “is my investment protected” is: no. Investing involves taking risks, and that’s just the way it is. However, there are certain situations that the SIPC can help you with, and if you want more protection you can always buy a put. In the end, whether it’s worth it is up to you: take the risk and the rewards, or play it safe and buy a put.

Shorting Stocks or Buying Short Selling Funds

You can short stocks or buy short funds and potentially make money when the market goes down. You do this by borrowing stocks when the prices are high and selling them immediately. Then, when the stock declines in value you buy the stock on the open market and repay the debt with cheaper shares. Again you can do this yourself or buy a fund that does it for you.

When you sell short you sell high and buy low. You just do it in an unconventional way.  It was tough for me to get my head around short funds when I first heard about them some twenty years ago. Don’t beat yourself up if this concept seems a little wonky to you at first. Just know that you can sell short or buy these short funds that are structured to make you money if the market drops. You can even buy leveraged  short funds that go up 2 %or 3% for every 1% the market declines.  These are considered very risky ventures.

“Put” Options.

Here’s an alternative way to buy stock market insurance, buy puts.  These are options which grant you the right to sell shares at a fixed price withn a fixed period of time.

Let’s say XYZ stock is trading at $100 per share right now.   You think the market is going to tank and take XYZ down with it. As a result of this, you buy a 6 month put option that gives you the right to sell that stock at $100 per share over the next 6 months.

 

For the moment, let’s say you got this one right. The market goes down and XYZ plummets to $50 per share. Lucky for you this happens within three months of you buying the puts. Once the shares drop you buy them on the market for $50 and exercise your option to sell them at $100. You’re a genius and just made yourself a nice bundle.