It’s that time of year again: egg nog, relatives and the 24-hour running of A Christmas Story. We all know that too much of any of those three could lead to a hangover, but the movie can definitely teach us something that Uncle Bob can’t. It’s not “don’t put your tongue on a cold flag pole”, which is important to know. It’s all about managing risk. So, how should one manage risk or fear? Buy a gun? Some go that route. Others just buy hair spray. What? When my mom thought Saddam Hussein was going to bomb Dallas, Texas back in 1991 she went out and bought a 6-month supply of water, chili, toilet paper and hair spray. I guess that makes sense as my mom’s name is SuEllen and she’s from Dallas. I’ll leave that one for another blog. Back to my point…managing risk. What is the optimal way to go about it as a retail trader?
In the financial world, most money managers think of buying puts as a form of portfolio protection. Portfolio protection can help your peace of mind, but hurt your portfolio’s bottom line. Why? Historically, buying put protection simply does not work. We can see in the below study from tastytrade that the cost of the put actually hurts the portfolio performance over time. Note: the study was done during a bearish time period, which should have been an ideal time for buying puts.
Here’s what the trade looks like at entry:
The trade works best in a choppy / bearish market while even making a little in a bullish market. That’s right. It can perform well even in a very bullish market (see year 2013). “That makes about as much sense as a milk bucket under a bull” quoting my first boss, a Texas Congressman. But it is true.
It is hard to find a more reliable trade for protecting a long portfolio or for keeping as a stand-alone trade than the Bearish Butterfly.
Happy Holidays to all and have fun watching a little more of A Christmas Story!
Written and contributed by John Wilson