One purchases insurance with the hope that it never has to pay out. We are experiencing a dramatic setback in global equity markets and a payout may occur. Fortunately, I purchased a form of portfolio insurance for the MR20 portfolio, when stock markets were calm (premiums were much more reasonable before the storm).
Background
The Japanese market fell 12% overnight. I suspect that major market players (hedge funds/momentum funds) have been overleveraged and now have to adjust their portfolios to reduce risk. The markets have rallied for many months and perhaps some investors forgot about these inevitable market corrections.
Benefit of Portfolio Insurance
With the S&P 500 puts (held in the MIR20 portfolio), the strategy is down 1.9% on the day. Without the puts, the portfolio would be down 4%.
The Puts were purchased for $1.41 each and are now trading for $17.50. I did not spend a large dollar amount on the Puts, having only purchased four contracts. Even still, they are assisting in minimizing the short-term pain.
I purchased this form of insurance to be activated if the S&P 500 fell 10% (currently, the S&P 500 is down 8.5% from the level that the Puts were purchased). Effectively, this insurance has a 10% deductible. Even though the insurance has not yet been paid out, the Puts have increased dramatically in price as investors buy insurance during the storm. This increased and liquid value is reflected in the MIR20 portfolio value.
It will be interesting to see how this plays out. I have a long-held belief, that mid-August is when markets typically recover from summer selloffs. My theory holds that the "big" money in the markets becomes more active as summer holidays come to an end.
regards, Tim
Tim Morton, CFA is a retired portfolio manager with 45 years of experience working with private clients. For the past two years, the editor of mortonir.com and a contributor to Barron's. My comments are not to be taken as investment recommendations. They are purely for discussion purposes. Please see your advisor for investment advice.
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