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How to protect your portfolio for less than $5

Stocks kicked off the week higher on Monday, right after the S&P 500 saw its best week of gains for the entire year. And with several potential catalysts for more volatility on the horizon, one trader is looking at a strategy to protect profits going into year end.

"It's probably a good time when the market is trading at all-time highs like this is to consider ways to hedge your portfolio," CNBC contributor Mike Khouw said Friday on CNBC's "Options Action."

Khouw said that with the Federal Reserve's December meeting and holiday season both approaching, investors should consider a put spread to protect against a drop of up about 10 percent, based on where the S&P 500 ETF (SPY) traded during its summer lows.

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Khouw recommends buying what's called a put spread, an options strategy that offers limited protection against the S&P 500. Specifically, Khouw suggested buying the January 209-strike put for $5 and selling the January 189-strike put for $1 to create a bear put spread for $4 each. The trade offers protection in the SPY ETF from $205 to $189 through January.

The SPY rose slightly on Monday morning, trading around 210. Khouw's trade would account for a more than 2 percent drop for the ETF to 205.

"The important thing is, the decay in that $1 option is going to offset a lot of the decay in the short term, especially in the 209-strike put that I get," Khouw said.

In addition, Khouw said costs are further mitigated by the SPY dividend to be paid out by January expiration.

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Sign up to receive exclusive Options Action content. Each month you'll receive an exclusive message from host Melissa Lee and insight directly from one of the members of our Options Action panel. Keep your pulse on the market with the Options Action newsletter.

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