Another week and another record high for the S&P 500, so why are the risk markets telling us to be wary? The elephant in the room is the US election, but there are also earnings, and lest we forget the wars. So, let’s say we own a one-million-dollar portfolio in high-flying US equities, and we want to buy insurance for a covid like drop in the markets of greater than 30%.
We can buy VIX futures. The last time the S&P500 fell by one-third, volatility more than tripled. That means we would have to buy $100,000 worth of contracts at current levels to be protected. Of course, the risk is that markets go higher. At that point, our VIX futures will likely fall in price by half, and we wasted fifty grand on insurance we didn’t need.
We could buy options. As ever, the risk is not trying to be too clever, but nothing wrong with buying some puts if we fear that markets could drop by quite a lot. The problem is whatever we are afraid of, so is the one selling us the leveraged insurance contract, and option premiums are priced accordingly.
We could also take some money off the table. If we sold half of our equities and markets fell, we could pick up all of our favourite stocks at lower levels. However, if markets rally, we will be forced to buy back in at higher prices. Ultimately, it comes down to this: is the likelihood of markets squeezing higher greater than the risk of a crash if either candidate wins?
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