E.g. If I am net long in my portfolio and I fear some headwinds I can buy a put or two for the peace of mind. Now those puts should be always considered as worthless, and it is just the price to pay for the peace of mind.
Similarly you sell options. Trading options on the other hand is just pure gambling. Even if you get the direction right you likely won't get the timing right (or the volatility).
edit: typo
Why don't you just change your allocation?
If you can't sleep at night because of your current portfolio, and gyrations that are occurring, or that you are worried could occur, I would say it's obvious that it's not suited towards your risk profile.
You're burning up some of the potential upside by spending money on the options, so why not simply take some money off the table instead and have a less complicated setup?
The best outcome for them would be if those puts expired worthless. When you insure your house, you don't usually wish for it to burn down.
I haven't acted and my portfolio took a -30% hit right after.
Your suggestion (to change the portfolio allocation) would mean temporarily selling stocks and holding money. That strategy has an unlimited loss potential[0] if the stocks rise before you buy them back. With puts you are limited to whatever you pay for them.
edit: [0] unlimited loss potential provided you want to keep the same stake at the companies
I would argue that money is a neutral position (adjusting for inflation which is nowadays quite low). After all, we buy stuff with money, not stock.
Now, selling short, that has an unlimited loss potential, but it's very very different from a cash position.
It’s the same as writing call options. There’s defined upside and unlimited downside.
"Loss potential" (downside risk) in finance refers to money you lose, not money you could have made by doing something else.
An investor who sells when they think the market is going to go downhill, with the intention to buy back later is not acting as an investor but as a trader.
That's why hedging with options is less risky (and less profitable in the best case).
edit: My use of word 'unlimited' applies if you want to keep the same stake at the companies. In money terms you cannot lose more than the value of your holdings.
But selling your position simply does NOT mean you take on "unlimited loss potential". It's simply being outside of the market, which means you're missing out on gains. It's not like selling stock is suddenly the same as shorting the same stock. I think the terminology here is clear-cut and well established.
But the way to understand this is to reframe your view of "money" from being some special, neutral thing to just being another asset.
At any given moment, you could own $1000, or some gold, or some bitcoin, or whatever else. There is nothing special about the fact that it's $ you're holding rather than DOGE or SPY.
So imagine a 2-asset world, that has SPY and $ in it. You are holding $1000 right now, and the market goes from 1 SPY = $1 to 1 SPY = $1000. That is a loss. Denominated in SPY, you just lost 999 SPY.
It does not have unlimited loss potential, I'm not sure why the poster said it did. It's the opposite - holding has unlimited upside potential(however slim).
You're leaving crucial information. You don't buy insurance (or puts) at any price. It has to make economic sense, and the person on the other side presumably has the same information.
The person on the other side is likely a market maker selling both kinds of options. The price is dictated by market.
Or bonds:
* https://awealthofcommonsense.com/2020/08/why-would-anyone-ow...
Rebalancing is a thing, though generally for risk reasons. It would/could have saved one's returns during the so-called Lost Decade of the 2000s with the S&P 500:
* https://www.forbes.com/sites/investor/2010/12/17/the-lost-de...
As your equities dropped, there's a good chance bonds would have at least stayed neutral, or even risen: so you'd sell some of those (sell high) and pick up equities at a discount (buy low).
There are even products available that do this automatically for you:
For one, altering allocations earlier may trigger short-term capital gains tax as opposed to long-term CGT. Hedging through options alleviates this.
You are correct. Buying options for peace of mind doesn’t make much sense.
Buying them to e.g. avoid being short squeezed, protect against a margin call or insure against losses that will get you fired does.
A good example from recently is Ford. Was trading at around $6 a few months ago and not too volatile. OTM calls were pretty cheap that were a few dollars up and essentially worthless at double the price. Anyone writing those was getting almost no premium. But then the stock took off quickly and hit over $12. Anyone who wrote those calls enjoyed none of those gains.
So even a stock like $F can move in very unpredictable ways.