How to protect your portfolio in market downside?

Hedging is the main concern of investors

​$S&P 500(.SPX)$ index down to 3991 on May 9 close, the first time fell below 4000 points since the April last year, while Nasdaq Composite Index $NASDAQ(.IXIC)$ has retreated by 25.7% since the year, falling to the level of two years ago.

What is the difference between this round of pullback and anytime in recent 10 years? I'm afraid the continuous weekly decline, has already amade it difficult for investors to balance their positions. Quantitative institutional's flee on some stocks and increasing their hedging makes the market more volatile. Individual investors may face the most severe situation in a decade.

The following may help investors those holding positions,

First, Try more industries and balance asset types.

In the past few years, the stock index has continued to reach new highs, technology companies made great contributions. However, when the pullback comes, they are also the first to bear the brunt. If you compare other industries at the same time, maybe the situation might not be so pessimistic.

For example, energy industry, has gained close to 40% this year, and the main weights are all rising. Consumer goods, tobacco, foods and utilities in the defense sector also recorded gains around 10-20%; while the raw materials depends, different materials showed different. When Most of the financial companies experienced considerable retracement, BUT the insurance industry is an exception. In addition, half of the companies in the pharmaceutical sector recorded positive earnings.

It means, there has been interflow between industries.

THe  change makes the current stock investment more conservative and flexible. It is very important to stay away from growth stocks or at least balance the portion of growth stocks, value stocks and some cyclical industries.

Second, choose cash asset other than the price return

The original purpose for most investors to buy stocks and is to pursue the stock price return. But if in the downward cycle, I'm afraid some "fixed income" products can give investors more protection.

Bonds with fixed interest payment are natually good choice, but don't forget that many companies pay dividends. Warrent Buffett (at least in the early days) is a famous dividend lover,

Dividend income can also get extra cash.

In addition, under the tight environment, companies who buy back are also good targets. This is one reason why $Apple(AAPL)$ outperformed the market this year.

Coincidently, those companies in the defensive sector pay more attention to dividends, such as energy, tobacco, daily consumption and large medical companies all have good dividend yields. Other financial companies will also provide shareholders with good dividend returns for a long time.

While some companies' share prices have fallen, their profit levels can still be maintained, and their dividend yields will also rise.

Third, appropriate hedging methods

When it comes to hedging at the level of individual stocks, derivatives are often used. For example, in order to protect some stock positions that may fall due to financial reports and other events, investors will buy some PUT or sell Covered CALL to hedge. Some stocks even have separate futures products.

For the hedging of the whole portfolio, there are more choices. However, it should be related to the overall Beta of the current portfolio.

For example, a portfolio with 50% $Apple (AAPL) $And 50%$Tesla Motors(TSLA)$, How to hedge the whole portfolio risk?

Obviously, short at 1: 1 $SPDR S&P 500 ETF Trust(SPY)$  is not complete, because AAPL's beta=1. 10, TSLA's beta=2. 05, which means the portfolio's beta=1. 575. That is to say, if you want to completely hedge this stock portfolio, you need to short it at a ratio of 1: 1.575.

There are many ways

1. Direct purchase of ETFs with reverse short index For example$ProShares Short S&P500(SH)$Or with levers$ProShares UltraPro Short QQQ(SQQQ)$. However, it should be noted that these short index products do not directly short all stocks, do not completely correspond to index fluctuations, and have management fees, leverage loss, etc., and the actual effect is very limited.

2. Directly short index ETFs, Including shortingSPDR S&P 500 ETF Trust$(SPY)$/Vanguard S&P 500 ETF$(VOO)$/Invesco QQQ Trust$(QQQ)$And so on, market index ETFs with good liquidity can basically track the market well, which is a relatively simple way. Of course, there is an extra cost to shorting, and there is also the risk of being recovered.

3. Derivatives through the market index. For example, stock index futures and options. These products are more complicated. For example, futures have contango, backwardation and other expenses, while options, whether they buy PUT or use Covered CALL, will face more "variability" and extra costs. 

Simple PUT can alleviate the market risk of sharp decline, while Covered CALL is more to protect the asset portfolio with a time fading. ,Cnce options are involved, we must know the delta, gamma and other information of the purchased options, and do a good job of hedging the corresponding proportion that we can bear.

4. Buy other financial assets related to the marketSuch as gold, national debt, etc. If you want to hedge the market through these, you must have a very deep understanding of the correlation between them and the market.

In a word, the current market volatility has indeed caused many investors to have some fears, and the market dominated by quantification is easier to enlarge the fears. Therefore, compared with waiting for death, it is increasingly becoming the survival rule of weak markets for individual investors to take the initiative to carry out some defenses when they have positions.