There are several ways to protect against (or even profit from) a market correction.
Ways to protect your portfolio
Long / short
Hedge funds do this by hedging, that is, buying a stock that they think is strong and selling short a paired stock that is weak. If you hold, say, a strong retail company in your portfolio, you might sell short an equal weight of a weak retail company.
These are like buying insurance on your portfolio. If you own 300 shares of XYZ, currently trading at $68, you buy puts at a level at a strike price that lets you sleep at night. For example, you might buy 3 XYZ 6-month puts with a strike price of $60.
A disadvantage is that the puts are wasting assets, that is, their time premium (which you paid for at the outset) becomes zero at expiration. (This is why it is like insurance. You wouldn't complain that your insurance premium was lost when you purchase insurance on your house and the house doesn't burn down, would you? Of course not. The purpose of the insurance is to protect your investment.)
Note that as these puts are married, they only protect your portfolio. Instead of profiting from a correction, you would merely protect your portfolio during a correction. (No small feat!)
If your portfolio is similar to the market, you can buy S&P index puts. If your market reflects a lot of technology, you can buy technology sector puts.
Say you have a portfolio of $80K that reflects the market. You could buy out-of-the-market puts (again reflecting your tolerance for loss). Any losses in your portfolio after the puts go in-the-money would be (more or less) offset by gains in the puts.
An advantage is that the bid/ask spread is smaller for the S&P. You would pay less for the protection. Also, the S&P puts are cash settled (meaning you get money put in your account on the business day after expiration day).
A disadvantage is that the puts do not linearly go up as the market drops. (Delta hedging is a big deal in and of itself.) Another disadvantage is that they are wasting assets (see the Married puts section, previous).
While the S&P puts can be used to maintain your market portfolio in the midst of a correction, you could purchase more puts than needed. If you had correctly timed the market, then your portfolio with puts would increase. (Your mileage may vary; some have predicted an imminent market crash way too often.)
Collars involve selling out-of-the-money calls and using the premiums to buy out-of-the-money puts. There are many varieties of collars, but the most straightforward is to sell 1 call and buy 1 put for every 100 shares. (This can also be done for index puts and calls.)
This has the effect of simultaneously:
- limiting your upside (the stock will be called away if it is above the strike at expiration) and
- limiting your downside (you can put the stock to the put seller if it is below the put's strike at expiration, or simply sell it for cash if you want to keep the stock)
You get your insurance for almost free. But again, it is protecting your portfolio.
Profiting from a market correction
Bear put spreads
As the name implies, you make money when the market goes bearish.
Bear put spreads involve buying puts at a close strike price and selling an equal number of puts at a lower strike price than the first. You have a defined maximum loss (the premium you paid for the higher put minus the premium you received for the lower put). You have a defined maximum gain (the difference between strikes minus the defined maximum loss).
Outright put buys
Buy S&P 500 index puts. If you buy deep out-of-the-money puts, it won't cost much, but you have little probability of it paying off. But if they go in-the-money, there could be a sizable payoff. This is similar to putting one chip on red 18 on the roulette wheel. But rather than paying off 35:1, it is a variable payoff. If you're $1 in the money, you just get $100. If you're $12 in the money, you have a $1200 payoff.
If you buy at-the-money puts, it will cost a lot, and your probability will be about 1 in 2 that you will pay off. In our roulette analogy, this is like putting 30 chips on the Even bet of the roulette wheel. The variable payoff is as in the previous paragraph. But you're more likely to get a payoff. And you will lose it all of the roulette ball lands on an Odd number, 0, or 00. (That is, the underlying of your put goes up or stays the same.)
Shorting overpriced stocks
If your research shows you what good stocks to buy, it may also tell you which stocks are ripe for a fall. You could short-sell these stocks or buy puts on them.
Shorting overpriced sectors
Similar to short-selling stocks or buying puts, you could sell short overpriced sectors or buy puts on them.
Short and double-short ETFs
There are ETFs that will allow you benefit from falling prices without needing to have a margin agreement or options agreement in place.
Sorry to have a lengthy answer. Many other answers emphasize that one shouldn't try to time the market. But that is not the OP's question. Provided here are both:
- ways to protect a portfolio during a market correction and
- ways to profit from a market correction.