After Friday's big sell-off, here's how investors can protect themselves from another drop

Published Sun, Nov 28 20218:03 AM EST

Jesse Pound @/in/jesse-pound @jesserpound

The news of a new variant of Covid-19 has sparked fear among investors and traders, but there are strategies for those looking to limit their risk -- and they may even generate some cash. One traditional options play to protect a portfolio against a downside move is to buy puts against broad market index funds, such as the SPDR S & P 500 ETF Trust (SPY). Puts are options that give the contract holder the ability to sell the underlying asset at a set strike price. By buying puts, a trader could potentially turn a profit if the fund falls below the strike price. Buying puts is also a low risk strategy. If markets rebound, then the put will simply expire, and the trader will lose only the premium paid to purchase the contract. For investors looking to bet against specific sectors, put options are also available on more targeted ETFs. For example, oil tumbled 13% on Friday as countries threw up more travel restrictions. That dragged down SPDR Oil & Gas Exploration & Production ETF (XOP) down more than 6%. If the sell-off continues next week, buying puts on this fund could prove to be a profitable trade. Other major ETFs that slid more than the broader market on Friday include the U.S. Global Jets ETF, which tracks airlines, and the Invesco KBW Bank ETF . On the other hand, bond and volatility funds jumped on Friday, making them a potential play in the other direction. For funds where investors think they may continue to rise, buying call options can make sense. Calls work in the same way as puts but serve as a bet that the underlying asset will rise above the strike price before expiration. The iShares funds for U.S. Treasurys (GOVT) and investment grade corporate bonds (LQD) both rose on Friday. A Barclays iPath futures fund for the Cboe Volatility Index (VXX) jumped 27%. Just like put options, buying calls limits the risk for traders to the premium paid for the contract. That could be especially important for these funds, as all three are down year to date even after Friday's outperformance and could resume their downward trends if fear over the new variant subsides.

A street sign for Wall Street is seen in the financial district in New York, November 8, 2021.

Brendan McDermid | Reuters

The news of a new variant of Covid-19 has sparked fear among investors and traders, but there are strategies for those looking to limit their risk -- and they may even generate some cash.