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What products can be purchased to insure against a large market drop, assuming assets involved are US, Canadian and Asian stocks (in the form of public company shares, mutual funds and ETFs)? Options are not available for some (they're not even marginable).

It is important that the underlying assets are not sold or transferred in a way that would trigger capital gains tax (Canada, but I assume most other countries would be similar).

Looking for realistic drop scenarios similar to what has happened in the past here, and in the post-1991 USSR etc., and not extreme gold, dehydrated food and guns type survival situations. It would help if the derivatives or whatever have been shown to behave in practice as-expected under stress.

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    Anything with a negative correlation to the market will protect you (long puts, inverse ETFs, shorting stocks/ETFs). Each has its own R/R spectrum. Collaring overvalued positions with options is a good way to do this at low/no cost but that isn't a possibility given your condition that the underlying assets are not sold or transferred in a way that would trigger capital gains tax. – Bob Baerker Mar 8 '18 at 14:52
  • I mean many people say Gold (but, who knows). – Fattie Mar 8 '18 at 21:48
  • There's nothing actually wrong with gold. Just avoid getting sucked in by the attitude that tends to go along with it. But be aware that gold pays neither interest nor dividends. I treat is as part of an portfolio of investments. – Simon B Mar 8 '18 at 23:46
  • @SimonB I don't think holding gold helped much in the 1987 and 2000 dot com busts. – Spehro Pefhany Mar 10 '18 at 2:36
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    @SpehroPefhany No, but it did really well in the recent banking crisis, when both shares and interest rates were falling. – Simon B Mar 10 '18 at 21:20
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Options will be the most cost effective method plus you have a predefined gain/loss profile. You said that this is not available for every security in your portfolio, so let's address those.

From a 30,000ft view, you can buy inverse ETFs on the indices where your securities reside or even put options on the index itself. While this is good for a generic market downturn, it doesn't come close to a perfect hedge.

For your individual securities, you want to think about the risks to those securities. Do you own mining companies where cost of capital is a major risk to the company's profitability? You can buy put options on sector-specific ETFs, use interest rate futures contracts, or even sovereign bond ETFs. I realize there are a lot more risk factors pertaining to a mining company, but this is to give you an idea of how you want to frame your thinking when analyzing your portfolio.

Since you don't want to transfer the securities and realize a capital gain, a lack of optionality in your portfolio doesn't hurt you all that much. You won't be at risk of getting assigned/auto-exercised since you can't buy options on the securities in the first place.

D Stanley makes a good point which is, no matter how you hedge (whether it be at a sector level or on the asset level with direct options), you are selling off some upside for downside protection.

Your last statement is really important. It is imperative to understand how liquid your hedges are. Some ETFs with optionality have great liquidity and therefore should operate as intended in a market downturn while some do not. Hedging at a sector level on an ETF with very illiquid options is usually more risky than hedging with asset-specific options. The caveat to this being the stock could be just as thinly traded as the options on the ETF.

Tying it all together: think about the risks to each security in your portfolio on an individual level AND on a portfolio wide level. Ask yourself, am I allocated too heavily to sectors/securities with high interest rate risk, high geopolitical risk, etc. Finally, when hedging at a portfolio level, Bob Baerker makes a great point which is that you want to reduce your overall correlation.

Hope that helps.

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One thing you might look for are capital protection products. I don't know specific products available in Canada or the tax implications, but that should get you started.

The problem with these products is that you give up some upside in good market years to help cover the bad market years, so their expected return is less that the market overall. So, for example, if the market grows 25% like it did in 2017, you might only see a 10% growth in these products, but your loss is limited (the upside in good years is taken away to pay for losses in bad years). So your overall expected return after fees will probably be closer to the risk-free rate of 1-2% right now.

You can create similar portfolios yourself using options and other derivatives to limit losses, but they cost money as well and can be a lot of work to manage.

Or you can ignore that complexity and just keep a good portion of your portfolio in very low risk instruments like government bonds or savings accounts.

  • Could you explain a bit about purchasing additional products as in your #3 suggestion, assuming the core assets are not sold or traded for other assets? – Spehro Pefhany Mar 8 '18 at 14:48
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I think that SlV and GLD are not extreme gold positions or highly leveraged ETF’s. They’re not a good investment during an immediate drop, but following the drop, depending on what the federal reserve does, they can be a good investment. As another poster mentioned, I love inverse ETF’s during a market drop, but be careful and skeptical of leveraged ETF’s. Historically however, during a short market drop, the inverse ETF’s have extended unusual returns (for a period of 2 or more days) which is an efficient market anomaly due to investor biases (fear). Bind ETF’s are also a good play during market drops historically, and respond with flights to safety.

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