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"Everything that goes up must come down. But there comes a time when not everything that's down can come up." George Burns

As we approach the last quarter of 2012, I just keep "staying the course" I set for 2012 and start thinking about 2013. The last few months have indeed been interesting. Notwithstanding that the market approached new highs, more and more investors seem less and less sure of what all this means. Should they get on the bull-train or run for the hills?

With the elections and the "fiscal cliff" still looming the picture is incomplete. Will macro fundamentals replace headline moves and if so, when? There are so many differing opinions on where we are and where we're heading it's near impossible to sort it all out.

I do know one thing for certain -- I must separate how I "feel" about things from how I "think" about things. Once I've done that, some clarity surfaces.

So, here's my thinking:

1) The "Bernanke Put" is real. Forget how I feel about it and whether or not it is damaging long term, it does place a floor under the market. I'm just not so sure if the current S&P 1450 is the floor, but I think a 15% to 20% drop to around S&P 1200 may well be the floor.

2) The macro problems are unlikely to resolve themselves within a year and this puts a ceiling on the market. I'm not sure if S&P 1450 is the ceiling, but I think a 15% to 20% rise to S&P 1700 probably is.

3) I will plan for portfolio protection based on these floor and ceilings. I'm more concerned about protecting my portfolio from a 15%-20% drop then accepting that drop and protecting below. I'm willing to "cap" my gains at 15%-20% for 2013.

Here's my plan:

1) For downside protection I will buy a September 2013 $145/$120 bear Put Spread. The $145 put costs $12.08 and the $120 put credits $4.62, for a net debit of $7.46.

2) Buying as many spreads as necessary to protect 130% of my portfolio value. For example, if my portfolio is $300,000, I will buy 27 spreads (27x$144x100= $388,800). Of the 27 spreads purchased, 21 represents the portfolio protection and the "extra" 6 will protect my weekly put sales.

3) Sell six weekly puts to recover the cost of the spreads. The 27 spreads cost $20,142 and that breaks down to about $400/week. That means I want my six weekly puts to generate about 67 cents in extrinsic option value ( 6x.67x100=$402) each week

Now, those familiar with my strategies recognize this technique, with the exception that I added the $120 "floor" to the put. This adaptation is to account for the "Bernanke Put."

Hang onto your hat, because we're not done yet ...

4) Buy a $150/$160 2-for-1 call ratio spread. This entails buying 21 September calls with a strike of $150 at a debit of $6.62 and selling TWICE (42) as many $160 calls with a credit of $2.88 each ... total credit of $5.76. The net debit on this spread is 86 cents/option for a total debit of $1,806.

An explanation is in order. Those that have employed my strategies are aware that setting the strike price on the weekly puts requires some skill. Do you go ITM, OTM or ATM? Mostly you need to go ITM to protect against a rising market and a see-saw market can cause headaches. It would certainly simplify things if you could just set the strike OTM for the extrinsic.

So, by adding this bull-call-ratio-spread, I take a little pressure off of the weeklies. I've covered an up market move from $150 to $160, so I can be more conservative with the weekly sales. In fact, when possible to achieve my extrinsic goal, I'd look to set the weeklies as far OTM as I can and still generate enough extrinsic premium.

This ratio-call spread starts to "give-back" at SPY=$160 and breaks-even at SPY=$170. Thereafter, it is effectively a short of 21 options. I'm not concerned with this from two perspectives:

First, my portfolio would have made the gains and I'm really only capping at an 18% rise ($170/$144).

Second, if SPY does rise above $160, I don't have to reset my $144 put, as the short calls provides the extra protection. In fact if SPY approaches $170, I'll jettison the $144 put altogether and just ride out the short call for protection.

In summary, I'm positioning 100% portfolio protection for a market with a trading range of SPY= $170 to $120. Perfect, it's not, but I just don't like sitting by and trying to figure out what's happening. This at least, keeps me in the game.

One note on margin requirements. The put spread and weeklies requires only the cash debit. If the weeklies are set ITM some very small margin will be used.

The ratio call margin is a different story. The margin requirement is about $1,800 per call, so 21/42 ratio uses about $38,000 in margin.

Also, IRAs can't use ratio calls, as they are, in essence, a spread and a naked call (naked calls aren't IRA available). This can be accommodated by buying a very deep OTM call (at say a $180 strike) and convert the ratio into two separate spreads (or an unbalanced condor, if you want to be picky).

In conclusion: Any investment position invites risk. Proper investing seeks to minimize risk while still allowing for reasonable gains. The strategy proposed here looks to manage risk, within the parameters established, and to do so without suppressing yields to intolerable levels.

Source: Portfolio Protection For 2013