Here's how to hedge your portfolio for less than $5

Volatility continued to surge Monday following a tumultuous week for the markets. The CBOE Volatility index, otherwise referred to as the VIX is now trading above 25, its highest level since late September--this as the S&P 500, Dow Jones industrial average and Nasdaq Composite have all fallen 3 percent or more month-to-date. With experts calling for heightened volatility in anticipation of the Fed announcement later this week, traders can seek monetary protection with a simple strategy.

"A reading [above] 25 in the VIX is above its historical average," Mike Khouw said Friday on CNBC's "Options Action." The VIX has traded below 20 for most of the year.

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Despite the potential for elevated volatility, Khouw said that from a long-term perspective, the chances of another financial crisis are slim. "An important thing to note is if you look at a chart of the S&P 500 going back to the 1960s, you see that these really big declines are rare," he said. Khouw added that there have been four major collapses in the last 50 years. "Other than that, most declines are actually contained to less than 20 percent and average closer to 10 percent," said the Optimize Advisors co-founder.

To hedge against further losses, Khouw suggested looking at a put spread. Specifically, Khouw recommended buying the S&P 500 ETF, the SPY, March 200/180 put spread for $4.85. In this strategy a trader will buy put and then sell a lower strike put of the same expiration to offset the cost. This trade is profitable if the SPY falls anywhere between $195.15 and $180 by March expiration. That's as much as a 10 percent decline from the current price of just above $200.

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"I'm looking 90 days out because that gives us a quarter to digest everything from the rate news to holiday sales," said Khouw.

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Host Bio

  • Melissa Lee

    Melissa Lee is the host of CNBC's “Fast Money” and “Options Action.”

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