Retirement Account Losing Value? Consider Options as A Protection Vehicle.

For many investors, a 401(k) plan is their primary retirement savings vehicle. While 401(k) plans offer many benefits, including tax-deferred growth and the potential for employer matching contributions, they are not without risks. One of the biggest risks facing 401(k) investors is market volatility, which can lead to significant losses in the value of their retirement savings.

One way that investors can protect themselves against market volatility is by hedging their 401(k) with a separate options account. In this article, we will explore why investors should consider this strategy and how it can help them achieve their retirement goals.

What is options trading?

Before we dive into the benefits of hedging a 401(k) with options, let’s first define what options trading is. Options are financial instruments that give the holder the right, but not the obligation, to buy or sell an underlying asset at a specific price, known as the strike price, before a certain date, known as the expiration date.

There are two types of options: call options and put options. A call option gives the holder the right to buy the underlying asset at the strike price, while a put option gives the holder the right to sell the underlying asset at the strike price.

Options trading can be used for a variety of purposes, including speculation, hedging, and income generation. In the context of hedging a 401(k), we will focus on using options to protect against downside risk in the stock market.

Why hedge a 401(k) with options?

The primary reason to hedge a 401(k) with options is to protect against market volatility. As we saw in 2020, the stock market can be highly volatile, with sudden drops in value that can wipe out significant portions of an investor’s retirement savings. By using options to hedge against this downside risk, investors can protect their portfolios from large losses while still participating in the potential upside of the market.

Another reason to hedge a 401(k) with options is to generate income. Options can be used to generate income in a variety of ways, including selling covered calls on stocks held in the 401(k) portfolio. This strategy involves selling call options on stocks held in the portfolio, which gives the buyer the right to buy the stock at a specific price before a certain date. In exchange for selling the call option, the investor receives a premium, which can be used to generate income or reinvested back into the portfolio.

Hedging a 401(k) with options can also help investors achieve their long-term retirement goals. By protecting against downside risk, investors can avoid the large losses that can set back their retirement plans. This can be especially important for investors who are nearing retirement age and have less time to recover from market downturns.

How to hedge a 401(k) with options

Now that we’ve established why investors should consider hedging their 401(k) with options, let’s explore how to do it. The first step is to open a separate options trading account with a brokerage firm that offers options trading. Many brokerage firms offer options trading, including Tradier.Com, Charles Schwab, and many others

Once the options account is open, the investor can begin to use options to hedge their 401(k) portfolio. One common strategy is to use put options to protect against downside risk. A put option gives the holder the right to sell the underlying asset at the strike price, which means that if the stock market drops often times the put option purchased will increase in value.

For example, let’s say an investor has a 401(k) portfolio consisting of stocks and wants to protect against a market downturn. The investor could buy put options on an index fund that tracks the overall market, such as the S&P 500 ETF, SPY. This would give the investor “control” over the SPY and any money made in the option could potentially be used to offset a loss in the 401K. This strategy is not impossible for a newbie investor but does require a bit more knowledge, timing, and education.

Sitting on the sidelines with a 401K and hoping it will “come back” is not always the best answer in all cases…using options is another alternative worth investigating.