Valuations are high, tech unicorns are inflating the market, trade barriers are going up, and interest rates are likely to rise in the next year. Meanwhile, volatility is low and options are cheap. Seems like a good time to protect one's portfolio while staying fully invested.
Here's the idea:
1) ~90% of my equity allocation in SPY at $247.40.
2) Purchase December 20, 2019 put options at the 250 strike price for around $24.68/share.
The price of the put represents 10% of the money protected and the duration of the protection is 877 days, or 2.4 years. This works out to a cost of 4.17% per year. Upside is not limited. The strike price is 1% higher than I'm paying for the stock, so the adjusted cost of 100% investment insurance for 2.4 years is 10%-1%=9%.
(I'm not accounting for the opportunity cost of the options premium because the riskiness or beta of my protected portfolio is probably similar to or greater than what I'd be comfortable with unprotected.)
Also, SPY pays a dividend of 1.87%/yr. Across 2.4 years, that's roughly 4.49%.
So over 2.4 years, my maximum loss is the -10% put premium, plus the 1% minimum profit on option exercise, plus about 4% dividends (assuming minor dividend cuts during a recession/crash) = -5%. My maximum gain over those 2.4 years is infinity minus 5%.
If I set up this portfolio and the stock market continued to climb, I would lag its performance by about 2.08% a year - which doesn't seem a high price to pay for having a 5% max downside in the current environment. 10y bonds aren't even that safe.
If I set up this portfolio and the stock market lost 40% 25%, etc. (pick your favorite scary number), I would only lose my maximum 5%.
FWIW, I'm 6 years to FIRE if I can average around 7% ROI during that period. However, the math says a market accident could add 2-4 years to that timeframe, which is the risk I'd like to hedge! In the event of an actual big correction, I would probably sell the puts gratefully and remain passively invested.
Is anyone else looking at a similar hedging setup? Have you found a less costly way to do it? Do you agree the price of protection is low right now?