What Portfolio Armor is:
A site that enables investors to insure their stock and ETF investments (including ETFs that track indexes such as the S&P 500 and the Dow Jones Industrial Average) against market downturns as well as company- and sector-specific risk with put options.
Why put options?
Only put options protect you against losses when stocks or ETFs jump or "gap" downward. Limit sell orders don't do this. For more on put options, and how they can be used to hedge your risk, see Portfolio Armor for individual investors.
How it works:
You enter your stock and ETF holdings, and the maximum downside risk you are willing to accept for each holding. Then, using its proprietary algorithm, Portfolio Armor shows you the optimal put options to buy to obtain the level of protection you want at the lowest price.
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4 comments:
Put buying does protect you against big drops in shares you may be holding but at a steep price.
This expensive insurance hurts performance if the underlying shares:
do nothing
go up slightly
go down slightly
go up a lot
If you think the shares you are holding have the potential for a big drop perhaps you'd do better to just sell them and buy something else with less downside risk.
"If you think the shares you are holding have the potential for a big drop perhaps you'd do better to just sell them and buy something else with less downside risk."
Investors can't always foresee what investments will have less downside risk. When Barron's recommended AIG a couple of years ago, for example, it generally wasn't considered a risky stock; it was considered a blue chip. Same thing with Sallie Mae, for example, a year earlier.
Also, moving from one stock holding to another offers little if any protection against systemic market risks. Further, investors often are wary of quickly selling a long-held, large position in a taxable account due to tax considerations.
That said, as with other forms of insurance, there is a cost, and the cost will vary based on a few factors. For example, it will generally be less expensive to hedge against a larger loss than a smaller one. Also, as with other forms of insurance, there are times when it may not make sense to have any insurance.
In some cases, the cost of protection may be higher than the loss you are looking to prevent. In that case, Portfolio Armor will inform a user that no optimal options exist. Aside from that, though, Portfolio Armor will not tell a user whether he should have insurance, or how much insurance he should have. As the site notes,
"Each investor is unique and one investor's risk tolerance may differ from another's. If you aren't sure about what your own risk tolerance is, or about how much protection you should have, you may want to consult with a licensed or registered financial professional to discuss this."
Your statement about "only puts protect you from gaps," is incorrect. If you are short an ETF it will protect you.
The advantage of puts over shorting etfs are: (1) volatility is low now. If market goes down volatility will increase and the put value will trade at a bigger premium, (2) the price you pay for insurance, the put purchase price, is known in advance and (3) you can buy puts in an IRA. You can't short an etf in an IRA.
That being said, it's a lot more precise to hedge a portfolio by shorting an ETF than it is with puts. Precision leads to efficiency. Efficiency leads to profits. A lot more math (i.e. assumptions) goes into figuring out how many puts you need to buy.
Anon,
"Your statement about "only puts protect you from gaps," is incorrect. If you are short an ETF it will protect you."
Shorting ETFs does not insure you against one of your stocks gapping down in price. Only put options on that security do that. Shorting index or sector ETFs doesn't protect you against idiosyncratic, or company-specific risk.
"That being said, it's a lot more precise to hedge a portfolio by shorting an ETF than it is with puts."
It is more precise to hedge each security in your portfolio with put options (if your securities are optionable) than it is to short ETFs. Again, shorting ETFs won't protect you against idiosyncratic risks. Also, with put options on specific securities, you can precisely modulate the level of protection you want on each security, e.g., using Portfolio Armor, you can determine how to hedge against a 24% loss in XYZ; a 31% loss in ZXY, etc.
Shorting index ETFs (or buying puts on them) can be a way to reduce the net long exposure in your portfolio, and to hedge against market risk (though not idiosyncratic risk). But if you are concerned with precision, it would be more precise to pair each of your long stock holdings with a short of a weaker stock in the same industry, i.e., to construct pairs trades (we mentioned an example here recently).
"A lot more math (i.e. assumptions) goes into figuring out how many puts you need to buy."
The whole point of Portfolio Armor is to do the math for you. And "math" does not equal "assumptions" in this case: Portfolio Armor's algorithm is model-independent and does not rely on any parametric assumptions.
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