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Summary

  • The article begins with a brief overview of the series and links to more detailed explanations from earlier in the series.
  • A summary of all candidate companies is included, with options data for each.
  • The article offers a discussion of which candidates are exhibiting the most weakness already, and my best prognostication about which options contracts will work best.
  • The article concludes with a comparison of the risks of employing this strategy versus not being hedged.

Back to Part X

In the Part I of this series, I provided an overview of a strategy to protect an equity portfolio from heavy losses in a market crash. In Part II, I provided more explanation of how the strategy works, and gave the first two candidate companies to choose from as part of a diversified basket using put option contracts. I also provided an explanation of the candidate selection process and an example of how it can help grow both capital and income over the long term. In Part III, I provided a basic tutorial on options.

I want to make it very clear that I am not predicting a market crash. Bear markets are a part of investing in equities, plain and simple. I like to take some of the pain out of the downside to make it easier to stick to my investing plan: select superior companies that have sustainable advantages, consistently rising dividends and excellent long-term growth prospects. Then, I like to hold onto to those investments unless the fundamental reasons for which I bought them in the first place changes. Investing long term works! I just want to reduce the occasional pain inflicted by bear markets.

We are already past the average duration of all bull markets since 1929. The current bull market has now surpassed in length all but three bull markets during that time period (out of a total of 15). So, I am preparing for the inevitable next bear market. I do not know when the strategy will pay off, but experience tells me that we are probably within 18 months of when we will need to be protected. I do not enjoy writing about down markets, but the fact is: they happen. I don't mind being down by as much as 15 percent from time to time. But I do try to avoid the majority of the pain from larger market drops. To understand more about the strategy, please refer back to the first and second articles of this series. Without that foundation, the rest of the articles in this series may not make sense and could sound more like speculating with options.

I would like to add one last thing about why I am hedging now, before I move to the candidates. The stock market has experienced a significant correction in every mid-term election year since 1962. The average drop has been 19 percent. This has been the weakest recovery in terms of GDP growth and jobs creation since WWII. Much of the growth in corporate EPS in recent years has come from cost-cutting and stock buybacks. The cost-cutting has probably run its course this time around. The global economy is still growing, but the rate of growth has slowed and much of the developed world is mired in sluggish, slow growth and unable to break out. Put it all together, and this year could see stocks pull back more than the average for mid-term election years. Just something else to think about.

In this article, I will provide a table for each candidate company, including the fields: current price, target price, strike price, bid premium, ask premium, possible gain (if target is reached), number of contracts needed to hedge 1/8th of a $100,000 portfolio against a 30 percent market plunge, the total estimated dollar amount of hedge protection, percentage cost of the portfolio for each position, and the most recent credit rating for the company from either Standard and Poor's or Moody's. I have included all put option contract strike prices that I would consider for the strategy for each candidate. The target price for each candidate remains the same regardless of the strike price.

All option contracts listed in the tables expire in January 2015. I have based all calculations upon the ask premium for each contract to keep things conservative. If you are able (which should be the case in many instances) to get a price below the ask price, all the calculated numbers will improve. Use common sense when entering a limit order by offering to buy at something above the current bid but below the ask premium. I usually try to split the difference and get most orders filled.

I would also like to explain what I do not include and why. I do not include contract strikes with fewer than 70 contract of open interest; in most cases, the cut-off is 100. I do not include contract strikes where the last price is far above the currently listed ask premium when there is also current volume listed. It is not clear what the price needs to be to get filled on those contracts. I do not include strikes that do not provide a possible gain in excess of 1000 percent (unless I believe it possible to get a fill below the ask price that will meet that expectation). The cost is just too high to fit within this strategy. Finally, regardless of the open interest, I do not include strikes that have no bid or ask premiums listed.

I have listed the candidates in groups according to where I think each is in terms of how soon I expect more weakness in the underlying stocks. In other words, I think that stocks of the first group are more likely to fall further sooner than the second group, which is more likely to turn south sooner than the third group, and so forth. I will provide my reasoning of why I grouped the candidates as I have, along with explanations on individual companies where I deem it necessary.

I will also provide a brief assessment of each candidate in terms of which option contracts listed in the table that I believe provide the best potential. If an investor decides to employ this hedge strategy, each individual needs to do some additional due diligence to identify which candidates they wish to use and which contracts are best suited for their respective risk tolerance. I do not always choose the option contract with the highest possible gain or the lowest cost. I will try to explain why I like the contracts that I do. I should also point out that in many cases, I will own several different contracts with different strikes on one company. I do so because as the strike rises, the hedge kicks in sooner, but I buy a mix to keep the overall cost down. My goal is to commit less than two percent of my portfolio value to this hedge. If we need to roll positions before expiration, there will be additional costs involved, so I try to hold down costs for each round that is necessary.

All prices and premiums are as of the market close on Monday, May 19, 2014.

The first five candidates listed are in no specific order of preference but, as a group, represent the most likely to see the respective stock prices fall the soonest. The group consists of Sotheby's (NYSE:BID), CarMax (NYSE:KMX), Veeco Instruments (NASDAQ:VECO), Jabil Circuit (NYSE:JBL), and L Brands (NYSE:LB). The stocks for each of these companies have already entered a down trend, and I expect that trend to continue. All five stocks are trading below the respective 200-day Simple Moving Average.

BID; S&P credit rating is BB. Current Price is $39.05. The target price is $16.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 28.00

$ 0.85

$ 0.95

1163%

3

$ 3,315

0.29%

$ 30.00

$ 1.20

$ 1.30

977%

3

$ 3,810

0.39%

BID is one of the most expensive candidates to employ, but it has a history of falling below that target price once a recession hits after a bubble in art and collectibles bursts, which is what I believe is happening now in China. I really expect that during a recession, BID will get closer to $10 a share. It is a tossup between the two strikes, since the amount of hedge protection provided by the $28 strike is much less than I prefer. I own some of both.

KMX; Moody's rates the securitized debt at Aaa. The current price is $44.56. The target price is $16.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 25.00

$ 0.10

$ 0.15

5900%

4

$ 3,540

0.06%

$ 30.00

$ 0.25

$ 0.35

3900%

3

$ 4,095

0.11%

$ 35.00

$ 0.70

$ 0.80

2275%

2

$ 3,640

0.16%

$ 40.00

$ 1.70

$ 1.80

1233%

2

$ 4,440

0.36%

KMX is still a bargain! I like the $30 strike contract the best. The $25 strike contract has a better return and cost profile, but I like to be a little more conservative and have the protection kick in at $30. Needing only .11 of one percent is still very cost-effective.

VECO; NR by S&P; Moody's has withdrawn rating. The current price is $31.85. The target price is $12.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 18.00

$ 0.05

$ 0.65

1233%

7

$ 3,885

0.32%

$ 20.00

$ 0.30

$ 0.85

1131%

5

$ 3,675

0.33%

VECO, like BID, is also expensive already. The chart looks terrible, and the stock is out of favor. But look at the spreads between the bid and ask premiums. I suspect we can do much better by placing limit orders closer to the low end of the spread. That will make this candidate much more cost-effective. I like the $20 strike at $0.50, because that would bring the percent cost down to .25 percent and increase the possible percentage gain to 1500 percent, both respectable.

JBL; debt rated at BBB- by S&P. The current price is $18.03. The target price is $7.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 10.00

$ 0.05

$ 0.20

1400%

13

$ 3,640

0.26%

$ 13.00

$ 0.25

$ 0.40

1400%

7

$ 3,920

0.28%

$ 15.00

$ 0.60

$ 0.80

900%

5

$ 3,600

0.40%

JBL has also fallen significantly already, but still has further to fall, in my opinion; especially if we have a broad market pullback or recession. Again, the spreads offer some room to improve the cost. I would like the $13 strike better at a $0.30 premium. That would bring the percent cost down to .21 percent. I prefer to keep the average percent cost of all positions below .2 percent, so this is in the ball park.

LB; debt NR by S&P; rated Ba1 by Moody's. The current price is $57.96. The target price is $16.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 31.00

$ 0.05

$ 0.15

9900%

3

$ 4,455

0.05%

$ 34.00

$ 0.15

$ 0.20

8900%

2

$ 3,560

0.04%

$ 39.00

$ 0.30

$ 0.45

5011%

2

$ 4,510

0.09%

$ 40.00

$ 0.35

$ 0.50

4700%

2

$ 4,700

0.10%

$ 41.00

$ 0.45

$ 0.55

4445%

2

$ 4,890

0.11%

$ 51.00

$ 1.90

$ 2.05

1607%

1

$ 3,295

0.21%

LB is another inexpensive hedge candidate. I own both the $34 and $39 strike contracts, but am considering adding some of the higher strikes as I complete my hedge. Which ones I add will depend on what my overall average cost percentage is and what else is available.

The next group includes seven candidates that appear to me to be ready to turn lower within the next few weeks. The group includes: Seagate Technology (NASDAQ:STX), Terex Corporation (NYSE:TEX), United Continental (NYSE:UAL), Goodyear Tire (NASDAQ:GT), E-Trade Financial (NASDAQ:ETFC), Morgan Stanley (NYSE:MS), and USG Corporation (NYSE:USG). I have tried to order this group starting with the weakest and continuing with the next weakest, etc.

STX; S&P credit rating of BBB-. The current price is $51.72. The target price is $20.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 23.00

$ 0.07

$ 0.13

2208%

13

$ 3,731

0.17%

$ 25.00

$ 0.10

$ 0.17

2841%

8

$ 3,864

0.14%

$ 27.00

$ 0.15

$ 0.22

3082%

6

$ 4,068

0.13%

$ 30.00

$ 0.27

$ 0.33

2930%

4

$ 3,868

0.13%

$ 32.00

$ 0.39

$ 0.43

2691%

3

$ 3,471

0.13%

$ 35.00

$ 0.62

$ 0.67

2139%

3

$ 4,299

0.20%

$ 37.00

$ 0.84

$ 0.89

1810%

2

$ 3,222

0.18%

$ 40.00

$ 1.30

$ 1.36

1371%

2

$ 3,728

0.27%

$ 42.00

$ 1.69

$ 1.78

1136%

2

$ 4,044

0.36%

STX offers an excellent value at $30 for a smaller portfolio. The $32 strike looks equally as good, until we look at what we get for the same money. The $30 strike contract provides $3,868 of hedge protection, compared to only $3,471 for basically the same cost using the $32 strike.

TEX; S&P credit rating of BB. The current price is $40.30. The target price is $12.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 15.00

N/A

$ 0.10

2900%

13

$ 3,770

0.13%

$ 18.00

$ 0.10

$ 0.15

3900%

7

$ 4,095

0.11%

$ 20.00

$ 0.15

$ 0.25

3100%

5

$ 3,875

0.13%

$ 23.00

$ 0.25

$ 0.45

2344%

4

$ 4,220

0.18%

$ 25.00

$ 0.45

$ 0.65

1900%

3

$ 3,705

0.20%

$ 27.00

$ 0.65

$ 0.85

1665%

3

$ 4,245

0.26%

$ 30.00

$ 1.10

$ 1.30

1285%

2

$ 3,340

0.26%

TEX will fall further if demand for raw materials in China does not improve. China has overbuilt and has stockpiled much of what it will need, so I do not expect an appreciable improvement anytime soon. I like both the $18 and $20 strikes best. If one can get the $20 strike contract for a $0.20 premium, that would be my choice. I own some of both.

UAL; S&P credit rating is B. The current price is $41.24. The target price is $15.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 18.00

$ 0.09

$ 0.13

2208%

13

$ 3,731

0.17%

$ 20.00

$ 0.18

$ 0.22

2173%

8

$ 3,824

0.18%

$ 22.00

$ 0.27

$ 0.31

2158%

6

$ 4,014

0.19%

$ 25.00

$ 0.50

$ 0.63

1487%

4

$ 3,748

0.25%

$ 27.00

$ 0.73

$ 0.80

1400%

3

$ 3,360

0.24%

$ 30.00

$ 1.24

$ 1.31

1045%

3

$ 4,107

0.39%

UAL is not as cheap as some in this group, but still offers some very reasonable entry prices. I like both the $20 and $22 strike the best. If you buy all the contracts at once, you should probably go with the $22 strike contract to save a little on commissions, since you will need fewer contracts.

GT; S&P credit rating is BB-. The current price is $24.95. The target price is $8.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 10.00

$ 0.05

$ 0.10

1900%

20

$ 3,800

0.20%

$ 12.00

$ 0.05

$ 0.15

2567%

10

$ 3,850

0.15%

$ 15.00

$ 0.20

$ 0.25

2700%

6

$ 4,050

0.15%

$ 17.00

$ 0.35

$ 0.40

2150%

4

$ 3,440

0.16%

$ 20.00

$ 0.80

$ 0.90

1233%

3

$ 3,330

0.27%

GT offers some good low-cost contracts. Why go below the $15 strike contract unless you can get the $12 strike for $0.10 or less? The higher strike provides better protection for a similar cost, in my opinion. I own both the $15 and the $17 strike contracts.

ETFC; NR by S&P; rated B2 by Moody's. The current price is $20.07. The target price is $7.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 10.00

$ 0.08

$ 0.22

1150%

14

$ 3,864

0.34%

$ 12.00

$ 0.20

$ 0.34

1371%

9

$ 3,924

0.31%

$ 15.00

$ 0.53

$ 0.63

1170%

5

$ 3,685

0.32%

ETFC has already fallen some, but has leveled off, thus the higher cost. But I really think this one will go to the target price in a recession or even a good correction in stocks. I own some of both the $12 and the $15 strike contracts.

MS; S&P credit rating is A-. The current price is $30.16. The target price is $12.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 15.00

$ 0.03

$ 0.07

4186%

13

$ 3,809

0.09%

$ 16.00

$ 0.05

$ 0.08

4900%

10

$ 3,920

0.08%

$ 17.00

$ 0.07

$ 0.10

4900%

8

$ 3,920

0.08%

$ 20.00

$ 0.16

$ 0.21

3710%

5

$ 3,895

0.11%

$ 22.00

$ 0.29

$ 0.34

2841%

4

$ 3,864

0.14%

$ 24.00

$ 0.50

$ 0.55

2082%

3

$ 3,435

0.17%

$ 25.00

$ 0.66

$ 0.69

1784%

3

$ 3,693

0.21%

$ 26.00

$ 0.86

$ 0.92

1422%

3

$ 3,924

0.28%

$ 27.00

$ 1.12

$ 1.16

1193%

3

$ 4,152

0.35%

MS is a mystery in terms of balance sheet transparency. I like any of the contracts with strikes of $17 up to $25. I will probably own more than two different contract strikes within that range before I am finished setting up my hedge.

USG; S&P credit rating is B+. The current price is $29.97. The target price is $12.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 20.00

$ 0.40

$ 0.65

1131%

5

$ 3,675

0.33%

$ 22.00

$ 0.75

$ 0.95

953%

4

$ 3,620

0.38%

As one reader pointed out, USG shares are being accumulated by Berkshire Hathaway. But after further consideration, I have decided to include it as a candidate. The majority of the shares Berkshire has a right to own are through convertible securities, with an average price below $21. If Berkshire wants to buy the rest of the outstanding shares at a premium (probably necessary to get board members and shareholders to approve), why would it not wait for an opportunity to get the rest at a price close to the average price it already has? Berkshire has no interest in propping up the share price by paying more than necessary for the remaining shares. Its time horizon is practically forever. So, if the shares fall enough below $21 to make a bid for the rest of the shares at that level look good, I think it will make a move. Until then, it is more likely to bide its time until the value is more evident, in my opinion. But I would prefer to hold the $22 strike contract, just to be safe. And I would also prefer to get it at a $0.80 premium if possible.

The next candidate finds itself in a league of its own. Royal Caribbean Cruises (NYSE:RCL) has leveled off, but has not yet established a trend. The best time of the year is just ahead for this company, and expectations are high. I suspect that all the good news is already baked into the stock price, so unless there is a positive earnings surprise or reported guidance is adjusted upward, I would expect this stock to trend sideways for most of the summer. If the broader market climbs higher, though, RCL could climb with it.

RCL; S&P credit rating is BB. Current price is $52.61. Target price is $16.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 20.00

$ 0.05

$ 0.10

3900%

10

$ 3,900

0.10%

$ 25.00

$ 0.10

$ 0.17

5194%

4

$ 3,532

0.07%

$ 28.00

$ 0.16

$ 0.23

5117%

3

$ 3,531

0.07%

$ 30.00

$ 0.24

$ 0.29

4728%

3

$ 4,113

0.09%

$ 32.00

$ 0.28

$ 0.36

4344%

3

$ 4,692

0.11%

$ 35.00

$ 0.42

$ 0.51

3625%

2

$ 3,698

0.10%

$ 37.00

$ 0.57

$ 0.66

3082%

2

$ 4,068

0.13%

$ 40.00

$ 0.89

$ 0.96

2400%

2

$ 4,608

0.19%

$ 42.00

$ 1.18

$ 1.24

1997%

2

$ 4,952

0.25%

I will be cruising with my family on an RCL ship (Oasis of the Seas; 220,000 tons) in the Caribbean in June. But I got a really good deal. In a recession, the discounts get even bigger. Mine was over 50 percent, and I booked well in advance. Margins will crumble if the economy contracts, and so will the price. This one is still cheap. I own some at $30 and $35, and am considering adding some at $37.

The final group consists of five candidates, all of which remain in an uptrend for now. The group includes: Tempur Sealy (NYSE:TPX), Micron Technology (NASDAQ:MU), Level 3 Communications (NYSE:LVLT), Williams-Sonoma (NYSE:WSM), and Marriott International (NASDAQ:MAR). But I do expect the stocks of these companies to fall more than the broader market if a recession hits the U.S., so I would not write them off because of the exhibited strength. If these stocks continue in an upward trend, it will just give us better entry points in the future at even lower costs.

TPX; S&P credit rating is BB-. Current price is $54.43. Target price is $12.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 20.00

$ 0.10

$ 0.20

3900%

5

$ 3,900

0.10%

$ 25.00

$ 0.20

$ 0.30

4233%

3

$ 3,810

0.09%

$ 27.00

$ 0.20

$ 0.40

3650%

3

$ 4,380

0.12%

$ 30.00

$ 0.35

$ 0.60

2900%

2

$ 3,480

0.12%

$ 32.00

$ 0.60

$ 0.75

2567%

2

$ 3,850

0.15%

TPX is tied to household formations, whether it is new homeowners or new renters. But household formations are below normal, and will recede further in a recession. My preference at this stage is the $27 strike, especially if I could get in at $0.30 or less.

MU; S&P credit rating is BB-. Current price is $26.94. Target price is $5.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 7.00

$ 0.02

$ 0.03

6567%

19

$ 3,743

0.06%

$ 10.00

$ 0.04

$ 0.06

8233%

8

$ 3,952

0.05%

$ 12.00

$ 0.08

$ 0.11

6264%

6

$ 4,134

0.07%

$ 14.00

$ 0.17

$ 0.20

4400%

4

$ 3,520

0.08%

$ 15.00

$ 0.23

$ 0.26

3746%

4

$ 3,896

0.10%

$ 16.00

$ 0.32

$ 0.35

3043%

4

$ 4,260

0.14%

$ 17.00

$ 0.42

$ 0.45

2567%

3

$ 3,465

0.14%

$ 19.00

$ 0.72

$ 0.75

1767%

3

$ 3,975

0.23%

$ 20.00

$ 0.91

$ 0.95

1479%

3

$ 4,215

0.29%

$ 21.00

$ 1.15

$ 1.19

1245%

3

$ 4,443

0.36%

$ 22.00

$ 1.43

$ 1.47

1056%

3

$ 4,659

0.44%

MU is still trending upward, but has a strong tendency to fall precipitously when the economy contracts. I believe that a recession would hit MU hard again. I really do believe that the target price is attainable during the next recession. Any of the strikes of $10 or higher will work. I am staying at $17 or below for the cost efficiency.

LVLT; S&P credit rating is B. Current price is $44.09. Target price is $12.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 17.00

N/A

$ 0.05

9900%

8

$ 3,960

0.04%

$ 20.00

$ 0.05

$ 0.15

5233%

5

$ 3,925

0.08%

$ 25.00

$ 0.20

$ 0.30

4233%

3

$ 3,810

0.09%

$ 27.00

$ 0.30

$ 0.45

3233%

3

$ 4,365

0.14%

$ 30.00

$ 0.50

$ 0.65

2669%

2

$ 3,470

0.14%

$ 32.00

$ 0.70

$ 0.90

2122%

2

$ 3,820

0.18%

$ 33.00

$ 0.85

$ 1.10

1809%

2

$ 3,980

0.22%

$ 35.00

$ 1.20

$ 1.45

1486%

2

$ 4,310

0.29%

A recession or significant market swoon in the range of 30 percent would hit LVLT hard, in my opinion. The company has done a lot to improve operations and is headed in the right direction, but if a recession comes too soon, management may find it difficult to maintain profitability. The stock price is still in an uptrend, but a recession could change that in dramatic fashion. I like the contracts with strikes of $25, $27 and $30 best, but the $32 strike also offers excellent cost efficiency relative to other candidates.

WSM; NR by either agency. Current price is $64.40. Target price is $20.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 30.00

N/A

$ 0.15

6567%

4

$ 3,940

0.06%

$ 33.00

$ 0.10

$ 0.15

8567%

3

$ 3,855

0.05%

$ 35.00

$ 0.10

$ 0.20

7400%

3

$ 4,440

0.06%

$ 52.50

$ 1.50

$ 1.70

1812%

1

$ 3,080

0.17%

$ 57.50

$ 2.70

$ 2.90

1193%

1

$ 3,460

0.29%

WSM stock is trending higher, but a stall in the housing market could devastate the stock again. Any of the strikes work. I am in at $33 and $35 so far.

MAR; S&P credit rating is BBB. Current price is $58.61. Target price is $24.

Strike Price

Bid Premium

Ask Premium

Poss. % Gain

# Contr.

Tot Est. $ Hedge

% Cost of Portfolio

$ 30.00

N/A

$ 0.15

3900%

7

$ 4,095

0.11%

$ 33.00

$ 0.10

$ 0.15

5900%

4

$ 3,540

0.06%

$ 35.00

$ 0.05

$ 0.20

5400%

4

$ 4,320

0.08%

$ 38.00

$ 0.15

$ 0.30

4567%

3

$ 4,110

0.09%

$ 40.00

$ 0.20

$ 0.35

4471%

3

$ 4,695

0.11%

$ 42.00

$ 0.30

$ 0.40

4400%

2

$ 3,520

0.08%

$ 45.00

$ 0.50

$ 0.60

3400%

2

$ 4,080

0.12%

$ 47.00

$ 0.65

$ 0.80

2775%

2

$ 4,440

0.16%

$ 50.00

$ 1.10

$ 1.20

2067%

2

$ 4,960

0.24%

Finally, MAR is rising also, but if travel budgets get cut due to a recession, EPS will fall and the stock price along with it. You can get great cost efficiency all the way up to the $47 strike. I own both the $33 and $42 strike contracts, and am considering adding some others if the market makes new highs.

I want to discuss risk for a moment now. Obviously, if the market continues higher beyond January 2015, all of our option contracts could expire worthless. I have never found insurance offered for free. We could lose all of our initial premiums paid plus commissions. If I expected that to happen, I would not be using the strategy myself. But it is one of the potential outcomes, and readers should be aware of it. And if that happens, I will initiate another round of put options for expiration in January 2016, using from three to five percent of my portfolio to hedge for another year. The longer the bull maintains control of the market, the more the insurance will cost me. But I will not be worrying about the next crash. Peace of mind has a cost. I just like to keep it as low as possible.

Because of the uncertainty in terms of how much longer this bull market can be sustained and the potential risk versus reward potential of hedging versus not hedging, it is my preference to risk a small percentage of my principal (perhaps as much as three percent) to insure against losing a much larger portion of my capital (30 percent). But this is a decision that each investor needs to make for themselves. I do not commit more than five percent of my portfolio value to an initial hedge strategy position, and have never committed more than ten percent to such a strategy in total. The ten percent rule may come into play when a bull market continues much longer than expected (like three years instead of 18 months). And when the bull continues for longer than is supported by the fundamentals, the bear that follows is usually deeper than it otherwise would have been. In other words, I expect a much less powerful bear market if one begins in 2014; but if the bull can sustain itself well into 2015, I would expect the next bear market to be more like the last two. If I am right, protecting a portfolio becomes ever more important as the bull market continues.

As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other's experience and knowledge.

Source: The Time To Hedge Is Now! Candidate Summary

Additional disclosure: I own put options as described in the article in all of the companies listed.