Equity markets have rallied and the VIX has fallen back below 20. While geopolitical tensions and tariff negotiations have simmered, there is still plenty of risk in the market. Outside of moving to cash or changing asset allocations overall, there are other ways to help protect portfolios against a spike in volatility.
Equity markets have rallied and the VIX has fallen back below 20. While geopolitical tensions and tariff negotiations have simmered, there is still plenty of risk in the market. Outside of moving to cash or changing overall asset allocations, there are other ways to help protect portfolios against a spike in volatility.
The first method would be to use options, primarily puts, to protect against equity market weakness. Puts are useful on individual positions or on broad market ETFs to help hedge against market risk. An added benefit of using puts is that it’s a long volatility instrument. With the VIX declining to more normal levels, buying puts makes much more sense than it did a month ago. For a more in depth look at using ETF options to hedge a portfolio, click here. There are plenty of other option strategies that can be used to protect against further volatility and downside movement in equities. Selling covered calls will bring in premium that acts as downside protection, but it does cap upside. Debit put spreads are a cheaper way to purchase insurance, since some of the cost of buying a closer to the money put is offset by selling a further out of the money put. Regardless, with the VIX back to more normal levels, downside protection via puts is acceptable right now.
Another avenue available is buffered or defined outcome ETFs. While I personally have written about the drawbacks to using buffered ETF products from a buy-and-hold perspective (click here for more), they can be useful in specific situations. The biggest drawback to using buffered ETFs on a long-term basis is permanently capping upside. However, if there are heightened risks of a pullback or market volatility, buffered ETFs offer some downside protection while still being able to participate in some upside. If market conditions clear up further, then moving back into unbuffered market exposure makes sense.
With so many buffered ETF products out there nowadays, it’s important to choose a product that offers the protection desired and still has at least most of its upside potential left. A good series to look at would be the February calendar series as the S&P 500 is back to early February levels. For example, the FT Vest U.S. Equity Deep Buffer ETF (DFEB) and FT Vest U.S. Equity Buffer ETF (FFEB) are roughly back to where their buffers were originally set, so investors should get the expected upside cap and downside buffer as intended. Both DFEB and FFEB use SPY as their reference asset but there are other versions that use QQQ or IWM. Using the correct funds for a specific reference asset and making sure the fund has the expected payoff structure in place when purchasing them is a very important point when implementing buffered ETFs.
