Worried about stocks? Here's how to buy protection

Warren Buffett once said to "be fearful when others are greedy and greedy when others are fearful." And with the decline in the so-called fear index — otherwise known as the CBOE Volatility index — some traders see an opportunity to be buy protection.

The VIX has fallen to 17 — its lowest level since before the August dip. Since the VIX measure prices for puts and calls on the S&P 500, the lower it goes, the less expensive it becomes to buy insurance in the form of put contracts. As uncertainty over the Fed, China and earnings season lingers, some traders are using the low VIX as an opportunity to protect their portfolios.

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"[The low VIX] is a perfect opportunity to buy insurance," options expert Mike Khouw said Thursday on CNBC's "Fast Money." "It's better to buy it when you can than when you have to."

To hedge against a potential turn in the recent rally, Khouw suggested buying a put spread in the S&P 500 ETF, the SPY. Specifically, he looked to purchase the December 200/184 put spread for a total cost of $4.45.


This is a bearish strategy where a trader will purchase one put and sell a lower strike put of the same expiration to offset the cost. The structure protects the SPY to $184, or up to 9 percent, through December expiration. Below that, a trader will see losses.

"You're spending about 2 percent of the total value of the SPY on this trade and the spread represents about $20,000 worth of the S&P 500," the Optimize Advisors founder said.

The S&P 500 was up 2 percent Friday morning.

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