So if you want to hedge a $100,000 portfolio against any major market decline this summer, you might buy September 150 Spider puts, each of which provides the right to sell 100 Spider shares at $150 per share through the third Friday in September. The puts were recently trading at $3.70, but since each put gives you the right to sell 100 shares, they cost about $370. The investor needs about six contracts to roughly cover their portfolio, so the total cost is $2,250.
If the S&P were to plunge 10%, you would have only lose about 3.7% on their portfolio, or about $3,700 instead of $10,000. The savings isn't as dramatic if the market dropped 5%, but you still come out ahead. Instead of losing $5,000, you're only down $3,700.
"You can hedge relatively cheaply while still having the upside exposure," said Price Headley, founder and chief analyst at BigTrends.com, an options research firm in Lexington, Ky.
Using puts is also a good alternative if you don't want to sell shares for tax reasons. However, it's wise to consult with an advisor when using these strategies.
In addition to Spider puts, investors are also buying puts in the Dow Diamonds, an ETF tracking the Dow Jones Industrial Average, as well as in the Powershares QQQ, which tracks the Nasdaq-100 Index and is known by its trading symbol QQQQ, said David Kalt, chief executive officer of OptionsXpress, an online brokerage.
The use of puts also reflects, in a sense, a more mature investing public, some experts said.
“It has nothing to do with speculation, it has to do with protecting gains in the market,” Frederick concluded. “Investors are much wiser and smarter, and the reason you don’t see the kind of euphoria you saw in 2000 is because people got burned back then. Now, they are being more pragmatic.”
Tara Siegel Bernard is a News Editor at CNBC.com. She can be reached at firstname.lastname@example.org.