Using put spreads

  

Hedging with bear put spreads

 

 

Using spreads instead of buying options outright can reduce risk and increase opportunity.

 Protecting a portfolio from a market downturn doesn’t have to be complicated. Find out which defensive strategy offers the most bang for your buck. “The simplicity of debit spread

Investors have had a tough time so far in 2008 as the S&P 500 index fell 18.3 percent from Jan. 2 to July 15. You could have minimized the impact of this decline by hedging a portfolio of stocks with long puts. But buying puts can be expensive, especially during downtrends when market volatility spikes. As the cost of buying puts rises, their effectiveness as a hedge wanes, and potential profits from a stock portfolio can suffer. Instead of buying puts for protection, you can add a bear put spread  to your portfolio. 

Both strategies protect against market declines, but a bear put spread is much cheaper because the lower-strike put you sell helps offset the higher-strike put you buy. The trade-off is bear put spreads offer less downside protection than straight long puts. But as long as the market doesn’t completely crash, these spreads offer several advantages over buying puts.

Long puts will completely protect a portfolio below the strike price, but they can be expensive.

Estimated costs and benefits Hedging with bear put spreads costs less and offers more benefits than simply buying puts.

 Adding a bear put spread doesn’t eliminate the likelihood of catastrophic loss, it just reduces it.