Hedging portfolio using index put options?

[Milu]

I have a quite tech heavy portfolio and due to quite sizeable gains I've began to start considering whether some sort of portfolio insurance strategy might make sense. In my current portfolio I am about 25% Cash and 63% Stocks (50% tech + 13% non-tech) and 12% Crypto. 

 

Obviously my sizeable cash percentage is somewhat of a decent hedge to start with, but I am looking into whether something like an out of the money put option on the nasdaq might also be useful. I'm quite comfortable with sizeable drawdowns (was happily deploying cash during covid panic and during the large tech drawdown in 2022. Can take drawdowns of 25-35% without batting an eyelid. Wouldn't mind clipping the tails a bit though and trying to be protected from drawdowns above a certain level. For example for drawdowns of 1% to 30% have no hedge but then be protected from the larger drawdowns of 30% plus. Seems like an index put option 30% out of the money makes the most logical sense but not sure whether the cost of the insurance would be too prohibitive for it to make sense.

 

For example if we think about round numbers let's imagine I had a 1,000,000 portfolio right now, 620,000 of this is in tech stocks and crypto. This is the part I'd like to try hedge from large marketwide drawdown (30% or more) in tech. The nasdaq ETF ticker 'QQQ' is currently at 495 so a 30% out of money put is 350. If I understand correctly to hedge this 620k I would need to divide 620,000 by current index level of 495 which gives 1252 and since options contracts are in blocks of 100 means I would need roughly 13 contracts of the 350 strike put option which is currently 14.98 for the June 2025 date. So the cost for this hedge is 13*14.98*100 = $19,474. Does that seem a bit high or have I gone wrong somewhere in my calculation?

 

Have people done anything similar before to protect their portfolios or do you mostly subscribe to buffets/munger approach of not bothering with buying puts, just deploy cash when things drop and ride out the volatility otherwise?

[pricingpower]

Safe Haven: Investing for Financial Storms is a good exploration of the topic by someone who has lived and breathed this style of strategy successfully (Spitznagel), particularly around the logic for choosing hedges (long dated rates payers?  rates receivers?  s&p puts?  gold forwards? etc).

https://www.goodreads.com/book/show/35541721-safe-haven

 

Your hedge sizing math is a bit odd (your example is hedging for a full 620k payout before premium cost if the nasdaq goes to 0?).  If you are trying to protect for losses after a 30% drawdown your max payoff should be 30% lower than your current portfolio size for example.  Option Volatility and Pricing by Natenberg is the classic book on options, personally I wouldn't trade options without knowing that book cold first and only do options trades when you also have a view on volatility pricing.

 

Buffett has long said that not selling is more a lifestyle choice for him than trying to maximize returns (see his partnership letters), it's Munger who was more arguing for holding compounders without respect to price. 

 

In options Buffett has also done basically the opposite of your trade, he wrote large notionals of long dated out of the money puts on the indices when he thought volatility was mispriced.