How to set-up alternatives in your portfolio to dampen volTo start off, diversification is an investor's best friend and most handy tool. When thinking about long-term investing or even if you are a day trader trying to protect all your gains without just sitting on the sidelines, one must implement alternative investment strategies in order to stay afloat and provide some stability to their portfolio.
To do such a thing, I would have 5 to 15% of your overall account value in cash ready to place these hedges. I will list 4 options to improve your portfolio's downside protection with #1 being the least risky and the most highly recommended for all types of investors, #4 being the riskiest and only recommended for those with large risk appetites.
1. A market-neutral fund:
This is a fund that tries to hedge risk with an investment mix consisting of short and long positions. I would suggest this to every single investor no matter your risk tolerance. I suggest a 5% position. BTAL is a good option that I use. If you have mutual funds, CVSIX is the way to go.
2. An income-generating alternative fund:
This is a fund that not only employs an alternative strategy but also pays a monthly dividend to allow for you to make new moves each month, padding other positions that have reached new lows as the bearish market conditions and turbulence continues. Now mind you, this is still giving you exposure to big holdings that have downside potential but you are in it for the dividends and strategies outside of equity. I would suggest a 5% position. JEPI is the best option, OUSA is the second-best in my opinion. JEPI sells call options in its strategies allowing for additional horsepower on the downside without you having to be monitoring a put or call option constantly.
3. Inverse ETFs:
These are ETF's that are inversely correlated to the overall index. When the market zigs, these zag. For example, SPXS is 3x leveraged to the downside of the SPX while SQQQ is triple leveraged to the NDX, so when the index is down 1%, the etf is up 3%. I would only suggest 1 to 2% in each of these. I would avoid shorting the DJI because the average yield of the Dow Jones is still safe in comparison to the 10-year treasury bill.
4. Selling Calls against existing holdings/buying puts
If you have holdings you really like but do not want to get rid of, you can sell call options against them. You have to have at least 100 shares for each single contract you sell. This is much more advanced and is only recommended to those who are savvy or fearless. Essentially, you say "Sure, if this stock hits this price, I will sell you my 100 shares at that price". The higher a strike price of the call that you sell, the less premium you will collect because the probability of it actually reaching that price is much lower. So for instance, if you bought 100 shares of a stock at $20, and it's now trading at $30, you sell a call at the $35 strike price for those $100 shares for $50 bucks; now there's two ways this plays out. (1) the stock hits the $35 strike and you get $3,500, locking in a $1,500 gain on your stock ($20x100=$2000) or you can always chose to buy it back if you think the stock is still going higher. OR (2) you collect that $50 bucks upon expiration if the stock doesn't hit $35.
Buying a put would be to profit from a stock going down; so for a really easy example, a put on the QQQ would be extremely similar to buying the inverse etf SQQQ because in both scenarios, the investment vehicles go up when the Nasdaq goes down. You essentially are placing a bet that the stock is going down. The nice thing about this is you don't have to put up a 100 shares as collateral for each contract and that your loss is predefined. So if you buy a put option expiring April 1st on the QQQ for $150, you max loss is $150 bucks. On the other hand; the market crashed and the option hit in the money; you could be looking at anywhere from 100 to 600% return. This in turn is used as dry gun powder on that terrible red day; same with your other alternatives. They can be thought of as placeholders of your buying power for when the sh*t hits the fan. What's worse than seeing a firesale day full of top-notch opportunities and having no buying power? Nothing. Be very cautious with buying puts and even more cautious with selling calls.
I'm still long the market! Btw if you want to play the DJI which should outperform the other two major indices; check out UDOW for 3x and DDM for 2x leverage. Happy trading
