Using Protective Puts with a long term investment window

Discussion in 'Stock Market Education' started by Douggler, Feb 13, 2016.

  1. Douggler

    Douggler Member

    Oct 2015
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    Something I've been considering but have been unable to find much advice on: If you are a buy and hold investor with a 20+ year investment horizon is it worthwhile to purchase protective puts?

    According to some research I found that the S&P500 has a 20% decline approximately once every 5 years or so. Let's say you are invested in SPY, currently trading at $186.63. A 20% drop would bring the price to about $149. To protect against this you buy a Mar 2017 $160 put at a cost of $9.77. This gives you a break even price of about $150, therefore if the market were to fall over 20% you would be covered.

    What I am struggling to understand is if this is something that would make sense with such a long investment window.
    1) As this put is good for a year, and on average a correction of 20% happens every 5 years this works out to about $4885 spent on puts over 5 years. Therefore your payout from this put has to be greater than this just to break even, plus cover you for losses on your underlying holding.
    2) Does investing that $4885 in the underlying instead over the course of the 5 years, (dollar cost averaging on a fixed schedule), give you a better return?
    3) What if you are worried about an extreme black swan event. Is there sense in purchasing extremely OOTM put options for protection?
  2. JR Ewing

    JR Ewing Super Moderator Staff Member

    Feb 2014
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    Puts are useful for more aggressive, tactical investors to make short to mid-term money on the downside of investments IF they should drop in value during that time you have puts on them. They are also useful to more conservative investors who may have a hard time stomaching short term volatility and want to "hedge" against it.

    It's largely an individual thing - if you can think longterm, have a strong stomach for whatever short term volatility lies ahead, and are well-diversified in a portfolio of mostly or entirely high quality, fundamentally sound companies, puts may not be something you want to spend money on.

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