Hedge your portfolio like an investing legend

From Ben Morris, Editor, DailyWealth Trader:

Everything that could go wrong has gone wrong.”

We may be heading for another major financial crisis.”

In late May, legendary trader George Soros made the comments above at a meeting organized by the European Council on Foreign Relations. In his keynote speech, he shared his views on how to save Europe from its current “existential crisis.”

You may or may not be interested in what Soros has to say on the topic. (If you are, you can watch his speech here.) But today, we’re more interested in what he’s doing with his money…

Soros is likely the greatest trader to have ever lived. Together with investment legend Jim Rogers, Soros managed their Quantum Fund to a 3,365% return over 11 years. Now, he manages $5.4 billion in his Soros Fund.

After hearing Soros’ concerned outlook, we wanted to see how he’s positioned in the markets. And what we found may help you in your own trading… especially if you’re worried about where the markets are headed.

This week is “Guru Week” in DailyWealth Trader (DWT)…

One of our goals in DWT is to pass along insights, strategies, and actionable ideas from the world’s best investors. These elite money managers have decades of experience, huge research budgets, the best contacts, and long track records of success.

We’d be fools not to “look over their shoulders” for ideas. So, once a quarter, we take a week to share our favorite ideas from these gurus.

Elite investors who manage at least $100 million are required to file forms (called “13Fs”) with the U.S. Securities and Exchange Commission (SEC) every three months. These forms detail which stocks they’ve bought and sold from one quarter to the next… and which stocks they held at the end of the last quarter.

The latest round of 13Fs – for the quarter ending March 31, 2018 – came in in late May. And Soros has his money where his mouth is. But maybe not in the way you’d expect…

Soros holds billions of dollars’ worth of stocks. He owns real estate businesses, banks, entertainment companies, semiconductor firms… even high-flying “FANG” stocks Amazon (AMZN) and Netflix (NFLX).

But at the end of last quarter, Soros held 7% of his portfolio – worth nearly $400 million – in put options.

Specifically, Soros’ 13F shows a 5% stake in puts on the SPDR S&P 500 Fund (SPY) and a 2.2% position in puts on the PowerShares Nasdaq 100 Fund (QQQ).

These are bets that the broad stock market indexes will fall. But within the context of Soros’ mostly bullish portfolio, we can see he holds those puts as hedges…

Normally in DWT, we suggest selling puts on great companies trading at good prices as a way to generate income. Buying puts is a much different strategyAnd it can save your portfolio in a market crash.

When you buy a put, you buy the right – but not the obligation – to sell a stock or fund at a fixed price for a set period of time.

Here’s how you could use puts to insure your portfolio…

Let’s say you own $100,000 worth of stocks. You can insure a portion of that amount against a crash… or even the whole amount. You can do this by buying puts on SPY, for example. When the S&P 500 Index rises 1%, SPY also rises 1%. When the S&P 500 falls 1%, SPY also falls 1%. It’s a good fund that tracks the index closely.

Even though you may not own SPY, the performance of the S&P 500 is similar to the performance of lots of stocks. So by buying puts on SPY, you get downside protection if the broad market drops. (You can use another index fund, like QQQ, if it is more closely related to your personal portfolio.

[Note: The scenario below reflects trading prices as of Tuesday, May 29.]

On Friday, May 25, SPY closed at $272.15 a share. If you’re worried about a crash in the next four months, you might buy the September 21, 2018 $260 puts for about $4.30 per share (or $430 per contract). The $260 strike price is 4.5% below today’s (May 29)  price… And the $4.30 is 1.6% of today’s price. So if the S&P 500 falls more than 6.1%, whatever portion of your portfolio you decide to insure is protected.

If you buy four $260 puts on SPY, you have the right to sell $104,000 worth of stock (since four puts represent 400 shares… and 400 shares times $260 per share equals $104,000). If your portfolio falls the same amount as the S&P 500 in a crash, your full portfolio (worth $100,000) is protected against a drop of more than 6.1%.

If the S&P 500 drops 25%, for example, SPY would fall from $272.15 down to $204.11. The September 2018 $260 puts – which allow you to sell SPY for $260 – would be worth at least $55.89 per share ($260 – $204.11 = $55.89)… That’s $22,365 for four put contracts.

Since you paid $1,720 for the four puts ($430 x 4 = $1,720) and you could now sell them for $22,356, your gain is $20,636. That’s just under 21% of your $100,000 portfolio.

In other words, your portfolio would have fallen 25%… from $100,000 down to $75,000. But because you owned the puts, your account dropped to $95,636 instead. You lost just over 4.4% even though the S&P 500 fell 25%.

Your insurance paid off.

Keep in mind, if stocks don’t crash, this proves to be expensive insurance. You lose nearly 1.6% of your portfolio value in four months. That’s why you may choose to insure a smaller piece of your portfolio. You could buy one or two puts instead of four.

In this market, it makes sense to follow Soros’ lead… The trend in stocks is still up, so you want to own them. But holding some insurance is always a good idea.

Now, we don’t recommend holding 7% of your portfolio in puts. That’s a big position. And we don’t know the duration of his puts, either. So they could expire at any time.

But as we said earlier, Soros is primarily long stocks. And he’s hedging some of that exposure with put positions in the big index funds. If you’re not holding any insurance in your portfolio today, it’s worth considering.

Ben Morris and Drew McConnell

Crux note: Going beyond the wisdom of the “Gurus,” Ben and Drew’s newsletter is informed by thousands of dollars’ worth of analysis from Stansberry Research… using both fundamental research and “common sense” technical analysis with the goal of helping readers learn how to use safe trading strategies to earn market-beating returns.

Find out more with a 100% risk-free trial to DailyWealth Trader.

× Subscribe to Crux
Want more posts like these?
Like us on Facebook?
Crux Contributors