New S&P Highs and the Cost of Insurance

This past Friday, 4/26/2019, the S&P 500 stock index, SPX, closed shy of a new high at 2939.88, marking a year-to-date gain of 17.27% from its 2506.85 close at 2018's year-end.

Much is written about the whys and wherefores of this new high. Little has been written about the cost of portfolio insurance. One sensible way to hold your current positions and still protect yourself from a market decline is to buy a put option-one of the least expensive forms of portfolio insurance.

If, like many of us, your investment portfolio consists of an S&P index fund or similar holding, you have an excellent choice of ETFs to choose from: SPY, IVV, VOO and more. Put options are readily available. 

The SPY is the world's largest ETF and SPY options may be the most liquid and lowest cost. Suppose we own 100 shares of SPY which closed 4/26/19 at $293.41 per share and we wanted to "insure" our portfolio at this market high for the rest of the year.

Which put option should we buy? Short answer is the end of year "quarterly" 12/31/2019 "at-the-money" 293 puts which closed at $12.29 (as marked by my broker) or 4.188% of the SPY closing price. Basically between now and the year end, the most you could lose on your SPY position is the 4.19% paid for the insurance. Gains, of course, would be 4.19% lower than if you didn't have the insurance. 

The above charts the gains and losses of this example. The green line is the gain and loss of the entire portfolio of SPY at 293.41 and the Dec 31 293 put. Let's parse this in insurance terms:

The coverage is 100 Shares of SPY at $293.41 per share;
The the term is time until expiration;
The payout is the $293 per share strike price*;
The "deductible" is the difference between the $293.41 closing price and the $293 strike price or 41c per share.

The put will pay you dollar for dollar if the SPY closes below 293 on expiration*. Anytime before expiration is less certain. Put prices can vary widely in the interim depending on the moves on the underlying. Of course, if SPY expires ABOVE 293, you don't have a loss and your insurance expires.

*The actual payout may require you to sell exercised stock and there's many more considerations with portfolio insurance including dividends, margin and commissions. Contact me for more information.

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Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.