📌 Do You Have Insurance?
Do you have car insurance?
Our household owns two cars, and according to SOFI, their combined residual value is estimated to be around $50,000 to $60,000. In comparison, I pay $200 per month for auto insurance from Geico. Even though both Geico and I are fairly confident that I won’t get into an accident, the possibility always exists.
In total, my annual auto insurance cost is $2,500, with a $1,000 deductible per vehicle. Since it is highly unlikely that both cars will be in an accident simultaneously, my actual insurance cost amounts to 5%–10% of the car’s total value—to hedge against a risk that has never materialized in my driving history. While writing this, I realize how astonishingly high this premium rate is, yet I have accepted it as the norm.
It’s not just me—millions of American drivers routinely pay these premiums without a second thought. Meanwhile, millions of retirement accounts and cash stock portfolios navigate the market without any insurance, fully relying on market confidence while being steered by both the informed and the uninformed. Unlike our cars, when the stock market “crashes,” it is often a massive collective accident, creating concentration risk—the phenomenon where, at the worst moments, all asset correlations converge to one, leaving no true safe haven.
📌 Have You Considered Insuring Your 401(k) and Stock Portfolio?
You might say, “It’s too expensive!”
You’re right. If we applied Geico’s pricing model to the stock market, a $1 million portfolio should be paying at least $50,000–$100,000 annually for insurance. In normal years, this almost equals the lower bound of expected equity returns. Understandably, you might balk at the cost and exclaim, “That’s robbery! I might as well not invest in stocks at all!”
But you’d also be wrong.
The probability of a market correction is far greater than most people psychologically expect—even though it looks like just a minor blip on long-term charts.
📌 S&P 500 Historical Correction Probabilities:
- 5% drawdowns: Occur 2–3 times per year.
- 10% corrections: Occur approximately once per year.
- 20% bear markets: Historically occur with a 15% annual probability.
These probabilities far exceed the odds of me getting into a car accident, yet most people dismiss them. If the market’s “insurance companies” (hedging mechanisms) could consistently compensate for these losses, the value of such insurance would indeed be around 5% per year.
(Why? Because effective risk hedging could theoretically increase the S&P 500’s CAGR from 7%-10% to 12%-15%, depending on backtesting methodology.)
📌 The Key to Beating the Market: Cheap Insurance
Theoretically, if we can secure market insurance at an annualized cost below 5%, we gain a critical tool to outperform the market over time.
The challenge? Finding cheap insurance.
There are four key factors to consider when buying market insurance:
1️⃣ Coverage Amount (How much insurance should you buy?)
2️⃣ Timing (When should you buy it?)
3️⃣ Hedging Structure (How should you hedge?)
4️⃣ Tail Risk Protection (How do you handle extreme market moves?)
This article will focus on coverage amount and timing.
📌 Coverage Amount: How Much Market Insurance Should You Buy?
Here’s the core recommendation:
💡 In most cases, you should continuously maintain one-month or two-month index protection covering a 10% drawdown of your portfolio.
- For a $1 million portfolio, this means maintaining a $100,000 insurance policy.
- The primary allocation should be to one-month contracts, with occasional two-month positions.
- We will discuss the reasoning behind this in future articles.
📌 Timing: When Should You Buy Market Insurance?
Previously, we discussed that VIX serves as the market’s “insurance pricing index.”
If you are sharp, you’ve probably realized: Insurance should be bought when it is “on sale.”
Indeed, market insurance companies sometimes price their policies irrationally low, far below their actual risk-adjusted value.
📌 Example of “Discounted” Market Insurance:
- Late last year and early this year, a 1-month bear put spread with a 5% deductible and a 10% coverage cap (we’ll explain what this means in another article) offered $3,000 of coverage for just 30-50 points.
- In other words, market makers were selling an RR (risk-reward) ratio of 100!
- For a portfolio targeting 10% financial insurance, this policy had a monthly premium of only 0.1% (annualized 1.2%)—far lower than the theoretical 5% we mentioned earlier.
Even though my insurance expired unused, I do not regret buying it. In fact, I was happy for days after securing such a bargain.
📌 When Markets Crash, Insurance Prices Explode
📌 In recent market turmoil, the same insurance policy skyrocketed in price:
- The same one-month bear put spread that previously cost 30-50 points soared to 1,400 points—a 30x increase.
- A put butterfly I had structured for this scenario surged 10x in value.
- The cost of insurance went from “on sale” to outright extortion.
You might say, “That’s robbery!” And I completely agree.
But it’s not entirely the market makers’ fault—most people completely refuse to buy insurance during calm periods, preferring psychological reassurance and wishful thinking instead.
The smarter approach? Buy insurance when it’s cheap, preferably with a two-month horizon, so you are covered during high-risk periods.
📌 When is Market Insurance “On Sale”?
📌 VIX as an Insurance Pricing Indicator:
- VIX < 16 → Insurance is cheap and worth considering.
- VIX 16–25 → Moderate cost, but reasonable if downside risks are concerning.
- VIX > 25 → Insurance is overpriced (if you’re buying at this level, you’re being gouged).
In investing, losing less is winning.
Hedging is a long-term process, not a reactionary one.
Many investors, shaken by recent corrections, will say, “Next time, I will definitely buy protection!”
But in reality, few will follow through when the time comes.
At IVAnalog.com, our mission is to help investors manage risk and highlight when it’s time to focus on “losing less.”
🚀 Stay tuned for the next article, where we’ll discuss different ways to hedge effectively!