Hedging Strategies For This Volatile Market

| About: SPDR S&P (SPY)
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It is still too early to see how this summer will play out. If by the end of July there has been no significant decline I am going to be bullish on the market. Until then there are a few things one can do to keep options open and protect against a potential sell-off.

Add to your cash position

This is probably the best option. There are two benefits. First, you don't lose any of it if the market tanks. Second, if the market tanks you have some dry power to go in. This would be a good opportunity to go through your portfolio and do a bit of cleaning, finding the weaker positions and taking them off the table. If you have some losses that you wish you were rid of sell them for the tax benefits. That extra cash will be available to go into the quality companies.

Buy gold

This one is a bit trickier and I would not recommend going overboard with it. Gold is prone to bubbles just like every other commodity and we are not sure how overvalued it is at the moment.

Gold Weekly

On a 3 and a half year weekly chart it seems to be reasonably priced at this level. Putting some cash into gold might be a good play and a hedge against inflation and a market decline. The GLD and IAU are both acceptable, although there is a lot of buzz around purchasing actual gold (mostly the doomsday predictors).

Sell covered calls and buy puts on the SPY

There is a strategy of selling covered calls and using that money to buy puts on the SPY. This is a decent strategy, but finding reasonably priced SPY puts is difficult. Far out-of-the-money puts are much cheaper and protect against a major sell-off. However, you risk getting called away on positions you do not want to sell. If your main concern is a catastrophic scenario this could be the right strategy for you.

Short leveraged index ETFs (if your broker allows it)

This method is a solid hedge if you are mostly concerned with capital preservation, and you do not want to commit a lot of cash. Shorting the SSO provides strong movement if the market tanks. If the market goes up you will lose on the SSO but make money on your core positions, thus providing the hedge. Because it is leveraged you can tie up half as much cash than if you were to short the SPY. You will also be benefiting from the tracking error. If you are heavy consumer staples and low beta utilities you might even make money with this. If the market goes up quickly you may lose, but the market usually drops more quickly than it rises.

SSO Daily

Trading the SSO cushions the fall should the market turn south. Instead of selling in May and going a way, a short in the SSO would have provided the same protection while enabling investors to hold onto their core positions and not incur tax obligations as well as the risk of not reinvesting later. If your brokerage house does not allow shorting of leveraged ETFs you can short the SPY, DIA, or QQQ.

Do nothing

For income oriented investors this may be the best option. Many investors have been in great companies for a many years, picking up dividends and seeing the companies stand up to the test of time. Playing around with your core positions often involves selling and missing out on a chance to go back in, ending up with a lost position. Staying put can often be the best case. However, should the market drop significantly as it did in 2008-2009 large potential profits may be lost. That is why I believe it is always important to have some cash around incase these dream scenarios become reality.

These methods are meant to cushion the fall and not necessarily act as absolute hedges. If I can limit my losses to 50% of what they would be otherwise then I have done a pretty good job.

Disclosure: I am long IAU.