Drawdown Protector

Most investors can tolerate 15-20% maximum drawdown. Be honest - if a 20% loss would cause you to panic sell, set your maximum at 15% and implement protection earlier. Better to have conservative limits you follow than aggressive limits you abandon in panic.

Stop-losses are useful but have limitations. They work well for individual stocks but can whipsaw in volatile markets. Consider portfolio-level drawdown protection (reducing overall exposure) in addition to individual stops. Stops are one tool, not the only tool.

Rules-based cash raising is different from discretionary market timing. You are not predicting the market - you are following a predetermined rule based on actual losses. When drawdown hits X%, you act. The rule removes prediction; it is reactive protection, not proactive timing.

Set recovery rules in advance. Example: when drawdown recovers to below 5% from peak, begin removing hedges. Or when A-VIX drops below 18 and market above 50-day MA. Gradual return is safer than immediate full investment.

Typical put protection costs 1-3% annually for near-the-money puts, less for out-of-the-money. Allocate based on your protection need and budget. A common approach: protect 50-100% of portfolio with puts 5-10% out-of-the-money, costing 1-2% per quarter.

Inverse ETFs are for tactical, short-term hedging - days to weeks, not months. Due to daily rebalancing and decay, long-term holding underperforms. Use BEAR when you need quick, simple protection, then exit when the threat passes. Do not hold as permanent hedge.

This will happen sometimes - no protection is perfect. The alternative (no protection) would have experienced the full drawdown if it continued. Accept occasional whipsaw as the cost of protection. The one time you avoid a 40% decline is worth occasional small costs.

Both have roles. Portfolio-level protection (XJO puts, cash raising) is simpler and protects against market-wide declines. Position-level protection (individual stops) handles company-specific issues. Use both: individual stops for stock risk, portfolio protection for market risk.

Hedge Ratio = Portfolio Value × Hedge % / (Index Level × A$25). For A$200,000 portfolio, 50% hedge, XJO at 7200: A$200,000 × 0.50 / (7200 × A$25) = A$100,000 / A$180,000 = 0.56 contracts. Round to 1 contract for approximately 90% hedge of the portfolio.

Use collars when: you want extended protection (3+ months) and cannot afford put premiums, you are willing to cap upside, market is range-bound. Use straight puts when: you expect recovery and want unlimited upside, for short-term protection, when IV is low making puts cheap.

Buy deep OTM puts (20-30% below current level) with 3-6 month expiry. Roll before expiry. Allocate 0.25-0.50% of portfolio annually to tail hedges. These will expire worthless most of the time but provide 10-20x payoff in crashes. Think of it as insurance premium.

Apply your rules to historical data: download historical portfolio values, simulate drawdown triggers, calculate when protection would activate, measure outcome versus buy-and-hold. Test across multiple periods including GFC, COVID. Rules that only work in one period may be overfit.