Imagine it is May 2007, and you have been asked in general conversation if you believed the world’s share markets could fall to their lows of March 9 2009. Imagine further that you had a healthy portfolio of stocks broadly based on the S & P 500, and the value of those shares was increasing steadily.

Unless you were an economic Nostradamus, I doubt that you would have answered you were expecting a bear-market, and you had made plans to profit from the contraction.

Further, I hazard a guess you would not have considered a risk management strategy to minimise the impact of such a scenario on your investment portfolio. If you had, you would have questioned the need for such a strategy, as the bull market seemed perennial.

If you were under 45, you would not even have thought of your retirement savings, if indeed you had any.

Sadly, this imaginary scenario is non-fiction. Thousands of investors from all around the world suffered falls in the value of their investments of 40% or even more. For many, leverage compounded their loss, often totally.

The facts are indisputable. Given the choice, people choose to self insure, or “take the risk” labouring under the misconception that disasters always happen to other people, not to them.

Insurance companies tell the same stories. How high incomes earning 20 or 30 somethings argue to their insurance advisers that they are healthy, they are “good drivers” or “don’t think it will happen” and refuse to protect themselves, their possessions, or their assets.

People focus on the cost of the protection, rather than the cost of the potential loss. In retrospect, such focus is demonstrably flawed. You need only ask a single parent or the victim of a house fire if insurance is a worthwhile strategy, and if the cost of insurance is justified.

Just think: had you been offered the opportunity to insure your portfolio or retirement savings, would you have considered the offer an imposition? A cost that you could not accept?

The cost of the myth, the myth that self insurance is a valid risk management strategy for portfolios, has been about 40% of most investors’ portfolios. If your portfolio was worth $500,000 the self-insurance premium was $200,000.

Calculation of the cost of protection is simple. The potential loss is estimated, and the statistical probabilities of such an event calculated.

The final cost to the insured, the “premium,”, takes into consideration other relevant factors particular to the type risk being covered. Of course, the insurer will also require compensation, and their profit is built into the cost, or is charged as brokerage.

Portfolio protection strategies have been used by canny investors for decades. Financial instruments such as Call Options and Put Options have been used since the early 70’s when the Chicago Board of Trade created the Chicago Board Options Exchange (CBOE) to trade options on a small number of New York Stock Exchange (NYSE) listed equities.

Prudent use of Options permits investors to protect their portfolios, and even profit from bear market conditions.

How much more have you to lose?

if you found the information useful, interesting, or just confusing, you can get informational videos and other free stuff by going to http://www.abfgroup.biz and look for the Options Education link. Thanks for your interest, Donal Fuller don@abfgroup.biz

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