Author Topic: Best way to buy an option to short the market  (Read 1995 times)

Fuzz

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Best way to buy an option to short the market
« on: January 13, 2018, 07:46:29 PM »
So I get this is market timing and understand the arguments against market timing.

Let's say I want to put 1-2% of my investments into an extreme short position. I am 100% comfortable with losing it all if the market goes up. In theory, I am hedging my current position (90% VSTAX 10% Bonds) and betting that we will have some sort of recession in the next year.

My ideal investment would pay out 20 to 1 or 100 to 1 if the market dropped 20-30% in 6-12 months. Ideally, I would have a long window to cash in the investment and the bet would be very cheap.

So: what's the best way to do this? Some sort of option? Short an ETF?

Playing around in Vanguard, I'm not approved to do this kind of trade and the options they have are limited. Is there a better platform to do this on? Set up an account with a different provider?

JAYSLOL

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Re: Best way to buy an option to short the market
« Reply #1 on: January 13, 2018, 10:46:27 PM »
I don't do any of that kind of trading, but it's my understanding you can lose more than an up-front amount when shorting.  Experienced investors please correct me if I'm mistaken or there is a way around this. 

theolympians

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Re: Best way to buy an option to short the market
« Reply #2 on: January 13, 2018, 10:53:38 PM »
Sounds like gambling to me.

grantmeaname

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Best way to buy an option to short the market
« Reply #3 on: January 14, 2018, 07:30:59 AM »
You could buy a put option that’s way out of the money. At most you can lose the entire premium paid for the option and no more, and the gain may be many times the premium if the market drops enough that the options are meaningfully in the money. However, you’ll lose the entire amount of premium in any other circumstance.

Should you? Absolutely not.

Frugancial Advisor

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Re: Best way to buy an option to short the market
« Reply #4 on: January 14, 2018, 07:36:43 AM »
I agree with everyone else that this is definitely speculative, however some people have high risk tolerances and you mentioned only 1-2% of your portfolio.

Look up Inverse ETFs, they essentially aim to track the opposite action of the market. Hypothetically, if you bought in at 9:30am and the market tanked that day, your holding would rise by that amount (after expenses of course).

Other than that, derivates (buying a put) would be another option.

SnackDog

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Re: Best way to buy an option to short the market
« Reply #5 on: January 14, 2018, 07:43:23 AM »
Just buy SPXU.

grantmeaname

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Re: Best way to buy an option to short the market
« Reply #6 on: January 14, 2018, 08:19:07 AM »
My ideal investment would pay out 20 to 1 or 100 to 1 if the market dropped 20-30% in 6-12 months.

MrSpendy

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Re: Best way to buy an option to short the market
« Reply #7 on: January 14, 2018, 08:35:56 AM »
SPY trades for $278.

$278*0.75 (25% down move) = $208.5.

June 29 2018 expiry $208 SPY options cost about $0.74. That's 0.26% of your investment for 6 month's of protection, which seems like pocket change. BUT that insurance has a high long term cost. Annualized it comes out to about 0.5%, which compounds over time to take away a good bit of your upside. Over 20 years, 0.5% gives away about 10% (assuming a 6% return). Over 30 it takes away 14%.

Note that if the market drops 30% (278*0.7=$194) then the puts would be worth about $14 or 18.5x your cost, not quite the 100x you're looking for. If you go shorter term you'd increase the payout, but it will be even less likely.

I call this "sacrifices to the hedging gods". Rarely does it pay off. It's basically a form of insurance. If you put 1% in this type of thing every six month's for 30 years you'll sacrifice 45% to the hedging gods (assuming there is no drawdown that allows them to pay off). I'll get you a better estimate of % of 6 month rolling periods with a drawdown of 25% or more at another time when I have the data. 

Additionally, you have "roll risk" which means the puts may only cost 0.2% of your investment for this 6 month period, but that may not necessarily be true 1 year from now or 2 years from now or 3 months from now. It can and likely will cost more (vol is historically low therefore it's historically cheap to hedge).

My point is your asking about "tail risk hedging/protection against a severe market drawdown". That exists in pure form: out of the money options on indices. But it's quite expensive over time and going overboard can be hazardous to your long term wealth.

Like the thread on "how to invest in oil futures", I can answer it directly and literally, but it's kind of like telling you the cheapest/best place to buy cigarettes. I may be factually correct in telling you how/where to buy them, but that doesn't mean they are good for you.
« Last Edit: January 14, 2018, 09:51:30 AM by mrspendy »

Fuzz

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Re: Best way to buy an option to short the market
« Reply #8 on: January 14, 2018, 11:01:28 AM »
Mr Spendy - Thank you for your response. You're exactly right: I want to do a little bit of tail risk hedging. Emphasis on little. Right now I am 100 percent long in the market. I would like to be 99% long and 1% hedged. I don't actually think this inconsistent with MMM, so long as the options are cheap.

But eff it, I understand the objections and want to do it anyway. Orthodoxy is for narrow minds :)

I am self-employed. My income is loosely correlated to broader market moves and our primary residence is very correlated to the market. In the happy event I lose everything on the option, the rest of my financial picture is doing pretty well. In the unhappy event I make money on the options, cash is good in a recession.

Fuzz

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Re: Best way to buy an option to short the market
« Reply #9 on: January 14, 2018, 11:17:52 AM »
The other point I make, and this is where I get into market timing and the thread may go off the rails, but volatility is historically low and these options are historically cheap...must be because we have a very stable genius in charge!

I don't anticipate owning or experimenting with these for more than a year or two. This isn't a commitment to some 30-year investment system/plan.

MrSpendy

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Re: Best way to buy an option to short the market
« Reply #10 on: January 14, 2018, 12:52:55 PM »
Sounds good. Any discount broker should allow you to do fully funded fixed downside options purchases (Interactive Brokers, Schwab, Fido, etc.).

By the way, just because I'm a curious fellow.

For the 31 years June 1986 - August 2017 , there were 369 6 month rolling periods

27% lost money
16% lost more than 5%
8.4% lost more than 10%
2.2% lost more than 20%
1.9% lost more than 25%
1.4% lost more than 30% (all of which are 1 time period: 2008/2009, the 6 months ended Feb 09 was a -42% drawdown)

As long as you have a clear perception of the potential costs (and probabilities of actual payout) and this helps you stay the course, and you keep the size of the overall hedging program at bay, then it's not going to kill you.

I speak from experience, having killed a few calfs for the hedging gods myself.

« Last Edit: January 14, 2018, 12:59:11 PM by mrspendy »

ChpBstrd

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Re: Best way to buy an option to short the market
« Reply #11 on: January 15, 2018, 01:31:18 PM »
mrspendy nailed it. I'll add 2 points.

There's a timing component as well. You must define when you'll sell the option. Will you sell if the market goes down 10%, leaving your portfolio unprotected if it goes down to 20%? Etc... If you set the cash-out number OR your strike price too far out, you might never hit breakeven and the insurance might do no good in a routine correction/recession. Set it too close and you'll pay dearly for the protection. You might plan to commit to holding each option position until, for example, X days before expiration, and then sell it and roll to the next 6 months/year/whatever, but in that timeframe the correction might have come and gone and it didn't matter that you had insurance - you just watched the value of the options rise and the stocks fall, then vice versa, ending up back where you started, minus the option premium!

Another note: You could pay for the cost of the protected puts by frequently selling covered calls. E.g. buy the 6 month puts and sell covered calls every month. This would obviously work best in a low-commission account. You'd lose if a sharp upturn in stock prices forced the sale of your shares.