Hey trader,
Something feels wrong with this market. We are sitting near all-time highs. The tape still feels off.
You are not imagining it. Right now there is about $2 of downside risk for every $1 of upside. The SPY has roughly 25 points of room left to reach 800. It has 50 points of air beneath it down toward 720.
Walking away from the market is not the answer either. Nobody nails the top on purpose.
I have just the thing for a moment like this. It is called the atomic hedge, and I built it for situations exactly like this one. It balances staying invested against real downside protection.
I put it on a $100,000 portfolio live. It cost me $178 out of pocket.
So what does $178 actually protect?
Here is how it works.
What the atomic hedge actually is
The structure is simple. I buy SPY puts to protect the downside, then I sell a call vertical to pay for them.
A call vertical means selling one call and buying a higher one above it. Essentially, that caps my risk on the short side while still bringing in a credit.
That credit covers most of the cost of the puts. My out-of-pocket expense drops to almost nothing.
One thing to be clear about. This hedges a stock portfolio. You would not use it on an options portfolio.
The screen that comes before the hedge
The hedge only works if your holdings behave like the market. Some of them do not.
VIX EQ tells me the implied volatility of the average stock in the S&P 500. It is sitting at 36 right now.
Anything above that line moves more than the average name. Those positions need profits taken before you ever think about hedging.
Look at IONQ. Out 30 to 35 days, its implied volatility is 85%. Against a VIX around 15, that is roughly 5.7 times.
The beta reads 3.1. Beta stops being reliable when correlation breaks down like that, so I use volatility instead.
At 46.6, a correction probably takes IONQ back to 32. That is a 14-point decline, about 30%, while the S&P 500 gives up five.
Names that fit this hedge are the larger, market-correlated positions. That includes Nvidia, Microsoft, Apple, consumer staples, and a normal healthcare stock like Medtronic. Rocket Lab, running near 100% vol, does not fit.
Building it on a $100,000 portfolio
I start by converting the account into SPY terms. At 776.20, a $100,000 portfolio equals 129 shares.
That means I am carrying 129 deltas of market exposure. I want to cut about a third of it.
Multiply 129 by .3333 and I get 43. That is my target reduction.
Here is exactly what I put on:
- The puts. I go out about 35 days to September and look for a 26 to 34 delta. The 30 delta was $6.50, which is not cheap to me, so I bought two of the 26 delta at $5.71. That covers 52 deltas.
- The calls. I sell the 40 delta call at 786 and buy the 792 above it, six dollars wide. I sell double the contracts, so four of them, collecting $2.41 each.
- The cost. The puts run $11.42. The call verticals bring back $9.64. I am out of pocket $178.
What it costs me, and how I manage it
Without the hedge, a 10% move either way is $10,000. Up at 855 I make it. Down at 700 I lose it.
With the hedge on, the picture changes. A 10% rally leaves me up $7,500 instead of $10,000.
A 10% decline actually turns positive, around $1,400. I treat that number as fool’s gold, because I would be rolling long before we got there.
The trade-off is a flat spot. From 776 up to about 800, I make nothing.
That window costs me $600 per vertical across four contracts. Add the $178 and the opportunity cost totals $2,578. Above 800, I participate in everything.
Management is light. If that call vertical drops to $0.25, I buy it back and uncap my upside.
If SPY breaks below 757, my put reaches roughly a 0.55 to 0.60 delta. I sell it, buy the next 30 delta in the same expiration, and pull $1,000 out of the position.
The ratio scales two to one. A $50,000 account runs one put and two verticals, $150,000 runs three and six, $200,000 runs four and eight.
I am not calling a top here. Institutions are hedging and their forward volatility expectations are extreme, which tells me the cost of protection is worth paying while it is this low.
Brandon Chapman, CMT
Creator of Ghost Prints
