Tools For Hedging Investments

by: Brian Gorban

In these volatile times, it's always wise to have some market hedges as even though we feel we will be 100% right on each and every investment, the harsh reality is that is far from the truth. When the market plunges almost 4% like it did last Thursday, that is just another reminder that safety must always be used. Here are some ways we can do that.

As I wrote in a recent article here, using ETFs that move in the inverse direction of the market allows us to have gains on the brutal days like we experienced yesterday. There's the ProShares UltraShort S&P 500 (NYSEARCA:SDS), which seeks to correspond to twice the inverse of the S&P 500's (NYSEARCA:SPY) daily performance. That means if the S&P 500 was down 1% this should be up 2%, or as was the case Thursday when it was down just over 3%, this should be up just over 6%, as was the case. If you're heavily invested in a particular sector, say financial stocks I've mentioned here and here, then you can trade the ProShares UltraShort Financials (NYSEARCA:SKF), which seeks to correspond to twice the inverse of the Dow Jones U.S. Financials Index.

Options provide a great tool for protecting the downside by using either puts or calls. The very basic strategy is if you own one of the stocks, such as the ones mentioned here, you buy a put, which essentially is buying insurance if the stock moves below that strike price. This protects the downside. But of course there is a cost for that put option, so it has to be determined on a case-by-case basis if the price is cost effective. Another way I like to protect from downside is through covered calls as I've written about here and here. This of course limits the upside. But I'm more than happy with the returns I garner if these shares exercise and if they don't, I have a nice option premium and will simply write more call options against my long holdings.

Stocks with high insider ownership and recent insider buying tend to have more price stability as there's a consistent buyer who strongly believes in the company rather than just switching positions at the market's whim. As I wrote about recently here, here and here regarding companies that have high insider ownership/recent insider buys, many of them trade with less volatility as they have strong price support. Many market pundits will point you toward the blue-chip high dividend paying stocks that I've mentioned here and here, but as we saw, without them having that strong internal purchasing power of an insider(s), the stock can move swiftly to the downside. Please be reminded that in the long run the stock should return to its intrinsic value when market psychology normalizes, but it's worth mentioning observations I've made over the almost 15 years I've been following the market.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FAS over the next 72 hours.