Saturday, February 7, 2015

The Short Guide to Insure Stock Market Losses

First time stock investors may ask, is there any way to buy insurance on stocks to prevent losses?
The stock market can give an investor great returns, but not without risk. To buy a share of stock is to acquire a share of equity in a corporation with returns coming from increases in the value of the asset or dividends paid quarterly or yearly. Stock prices can increase due to a number of factors, expected or unexpected. If a company is set to acquire another company or if their earnings exceed expectations the stock price may surge higher. While investing in stocks can be lucrative, however, most investors are not the next Warren Buffett. Investors unaware of the risks and basic strategies of trading are susceptible to investment blunders.
First time stock investors may ask, is there any way to buy insurance on stocks to prevent losses? At the moment, purchasing insurance for stocks isn't as easy as buying a policy for your portfolio. There are ways to insure, or hedge, against stock market losses, however. Diversifying your portfolio and utilizing variety of options can help prevent an investor’s stocks from suffering substantial losses.
To diversify a portfolio is to reduce your non-systemic risk by investing in a variety of assets. Through diversification, the net loss realized from a decrease in stock prices will balance returns from other assets. When approaching a diversifying strategy, it is important to spread the wealth between investments with constant and volatile returns. With respect to the stock market, safe stocks are ones which do not witness volatile movements in prices and pay dividends. Investing in a whole index such as the S&P 500 or Dow Jones Industrial Average, which encompasses many stocks, are a more effective strategy to insure individual stock investments. Bonds, commodities, currencies, and funds are also valuable assets to diversify a portfolio. In particular, U.S. Treasury Bonds backed by the U.S. government are deemed by the most conservative investors to be the safest asset. A portfolio that holds a percentage of 10 to 30 year U.S. Treasury Bonds can ease risk-related stock market losses. (For more, see: Risk and Diversification: Different Types of Risk.)
Stock Options
Options can be a valuable tool to hedge risk and insure stock losses. An option is a contract between two parties in which the buyer has the right to buy or sell a stock at an agreed upon price within a pre-determined date. A call option gives the investor the right to purchase a stock at a strike price with the expectation that the stock will increase in value beyond the strike price. Conversely, a put option gives the investor the right to sell a stock at a strike price with the expectation that the price of the underlying stock will decrease. Purchasing stock options for individual stocks is a valuable way to protect risk related losses associated with volatile stocks.(For more, see Investopedia's Options Basics Tutorial.)
Other Types of Options
While stock options can be a safe way to mitigate risks of investing, there are a variety of different options that give investors leverage and market exposure. Like stock options, index options are a financial derivative which draws its value from an underlying index. The contract owner has the right to buy or sell a basket of assets such as the S&P 500 or Dow Jones Industrial Average. In particular, index put options provide insurance to investors in a bear market. During a bear market, assets in an investor’s portfolio will decrease while an index put option will generate positive returns. Like index options, ETF options insure a sector of stock investments. ETFs options can replicate whole indexes or specific sectors such as energy, healthcare and technology.  While index options are cash settled, ETF options can be settled in the underlying asset.  Different from both index options and ETF options, VIX options allow traders to speculate on market volatility without factoring in the price of the underlying instrument. As cash settled asset, VIX options are a great way to diversify and hedge portfolios. (For more, see: The 4 Advantages of Options.)
The Bottom Line
The stock market is very unpredictable with profits and losses realized every day. Insuring your investments can be valuable means to prevent substantial losses. Diversifying your stock portfolio is essential for any investor in the stock market. By diversifying a portfolio, an investor will acquire assets uncorrelated with the ones they currently own so as to balance losses. Diversification can be done by a variety means and not only by purchasing a variety of stocks. Bonds, commodities, funds and particularly options are a valuable method to insuring your stock investments.

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