Buying Insurance for Your Portfolio: Put Options vs. Trend Following

Trend following isn't the only way to protect against downturns. We compare trend following to the "guaranteed" protection of put options, and calculate the true cost of that certainty using SPY as our proxy for the S&P 500.

AlgorithmicFIRE • 2026-01-25

Video Summary

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In a previous post, we explored trend following as a mechanism to defend your savings against prolonged market stagnation. We showed how a rules-based system could help you step aside during major crashes (like 2000 or 2008) while staying invested during bull markets.

But trend following has a hidden cost: whipsaw.

Since trend following relies on lagging indicators (like moving averages), it will always be late to the exit and late to the re-entry. In choppy markets, you might sell at the bottom of a dip only to buy back higher, slowly bleeding capital while the market goes nowhere. For some investors, this uncertainty—"will the algorithm work this time?"—is stressful.

What if you could just guarantee that your portfolio won't drop more than a certain amount?

You can. It's called a Put Option.

What is a Put Option?

Think of a Put Option as term life insurance for your stocks.

You pay a premium upfront (just like your insurance bill).
In exchange, the insurance company (the option seller) guarantees to buy your stocks from you at a set price (the strike price) for a set period (expiration).
If the market crashes below that strike price, you are protected dollar-for-dollar.
If the market goes up, you only lose the premium you paid.

Crucially, unlike trend following, there is no "lag". The protection is contractual and instant.

Options are available on a variety of securities. We will be using SPY (an S&P 500 index ETF) as our example. Pricing, liquidity, and availability will vary based on the security you choose. Do your own research before making a decision to trade options on ANY security.

Put Options: The Technical Definition

A put option is a contract that gives the holder the right, but not the obligation, to sell an underlying asset at a specified price (the strike price) on or before a certain date (the expiration date). The seller of the put option receives a premium from the buyer in exchange for taking on the obligation to buy the asset if the option is exercised.

The Cost of Certainty: A Real World Example

Let's look at what it actually costs to insure a portfolio of the S&P 500, using the ETF (Exchange Traded Fund) SPY.

Suppose you have 300 shares of SPY ($206,700 value) and you want to ensure that—no matter what happens in the economy—you cannot lose more than 30% (relative to the current price of $689) over the next year.

Here is the math:

Current Price of SPY: $689 (2026-01-25)
Your Position: 300 shares ($206,700 value)
Protection Goal: Cap losses at 30%. You want to be able to sell your shares for at least $480 (~ $689 - 30%).

To achieve this, you buy 3 Put Option Contracts with a strike price of $480 that expire in about 1 year (e.g., Jan 15, 2027).(Note that options contracts are for 100 shares each, so we need to buy 3 contracts to cover 300 shares.)

The Cost Calculation

Options are priced based on volatility and time. For a 1-year contract protecting against a crash that takes the price of SPY to $480 or less (called "Out of the Money", or OTM), the market charges a premium.

Strike Price: $480 (approx 30% OTM)
Option Premium: Estimated at $6.80 per share.

Total cost to insure your 300 shares: $$ 300 \text{ shares} \times \$6.80 = \$2,040.00 $$

As a Percentage of Your Portfolio

$$ \frac{\$2,040.00 \text{ (Cost)}}{\$206,700 \text{ (Portfolio Value)}} = \mathbf{0.99\%} $$

In this scenario, you are paying roughly 1% per year to guarantee that you can, during the next year, be assured that you can sell your shares for market price or $480 (whichever is higher).

If the SPY drops to $470? You have the right to sell your shares for $480
If the SPY drops to $300? You have the right to sell your shares for $480
If the SPY goes up to $900? You can sell your shares for $900, or continue holding them. Either way, your options cost 1% of the portfolio, and that money is gone.

Different levels of protection and/or different time horizons will cost different amounts. I.E. to protect against a 20% loss for one year, instead of the 30% loss protection for one year in this example, the premiums would raise the cost to about 2% of your portfolio.

The cost of options is not fixed. It varies based on market conditions, including volatility, interest rates, and the time to expiration. The prices quoted above are estimates based on current market conditions.

Trend Following vs. Put Options

This is a false choice. You can use both. The different strategies serve different purposes.

Based on our data, trend following works quite well on bonds.
- Bonds are a good candidate for trend following because they are less volatile than stocks, and they are less sensitive to market sentiment.
Trend following also works well on stock ETFs, particularly when used in a tax-deferred account.
- Stock ETFs are less volatile than individual stocks. The ETF is a basket of stocks, thus the ETF filters out some of the volatility of the individual stocks.
Trend following works less well on individual stocks. It works better on mature stocks that trade on traditional valuation measures, and less well on meme-type stocks that trade on sentiment and hype.
Trend following also does not work in fast moving markets, and is thus subject to the risk of major market or geopolitical events.
Put options are a guarantee, with a known but fixed cost.

Put options are only available as contracts on 100 shares each. The positions you cover are probably not in integer multiples of 100. If you use put options to hedge part of a position, you can use trend following to hedge the rest of the position.

Some Important Considerations

All price quotes above are nominal, and were approximate based on the date of writing this post.
The potential loss is based on the put option's strike price. The loss is not a percent of your portfolio.
- If SPY increases in value to $960 before dropping below the strike price of $480, the loss from peak to strike price is 50%.
There are additional costs not mentioned above, such as: commissions, bid/ask spread, the cost to close an in-the-money option, etc.

Conclusion: Insurance vs. Discipline

This 1% "tax" on your returns is the price of certainty.

Put Options provide a hard floor. You sleep well at night knowing exactly what your worst-case scenario is. The downside is that this cost is guaranteed every single year, whether the market crashes or not. Over a decade, a 1% annual drag significantly reduces your compounding.
Trend Following aims to provide similar protection essentially for "free" (by simply moving to cash), but it charges you in uncertainty and false alarms.

There is no free lunch in investing. You explicitly pay the option seller for insurance, or you implicitly pay the market in whipsaws and attention. The choice depends on which cost you are more willing to bear.

This post is not meant to be a primer on options trading, but instead to highlight the trade-off between uncertainty and cost, and to demonstrate one method to protect your portfolio. Anyone interested in trading options is going to need to consult a professional financial advisor and do their own research.

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View Video Transcript

All right, let's talk about something that's on every investor's mind. How do you protect your hard-earned cash from a big market crash? Today, we're going to dive into a strategy that's basically a literal insurance policy for your stocks. I mean, this is the big one, isn't it? It's the question that keeps you up at night. You know, we need to stay invested for the long run, but that fear of another 2008 style meltdown, it's always kind of lurking there in the back of your mind. So, a really common strategy people use is called trend following. The idea is you have rules that tell you to sell when the market starts to drop. The problem, it's always a little late to the party. And in those really choppy sideways markets, you just end up selling at the bottom of a dip and then buying back in when it's already higher. It's this nasty thing called whipssaw. And it's just a slow, stressful way to bleed your account dry. So, let's just forget all the complicated rules and the second guessing for a minute. What if you could just draw a line in the sand? What if you could get a contractual guarantee that says, "Nope, my portfolio cannot fall below this number." Well, it turns out you can. And that brings us to the core of this whole thing, using something called put options. And honestly, the best way to think about them is exactly what it sounds like, real insurance for your portfolio. The analogy is just perfect, and it makes a complex idea feel really simple. Okay, so let's get into it. A put option is just a contract. That's all it is. You pay a small fee, and in return, you get the right to sell your stock at a price you both agreed on ahead of time. And notice I said the right, not the obligation. It's your choice, your safety net. And what's really cool is how the lingo lines up perfectly with regular insurance. The premium is, well, your premium. It's the bill you pay for the protection. The strike price, that's your coverage amount. It's the guaranteed price you can sell at. And the expiration is just the term of your policy. You know, how long it lasts. So, here's the most important part. Remember that whole whipssaw problem with trend following the lag? With options, that's just gone. The instant your stocks drop below that guaranteed price, your protection kicks in. It's immediate and it's written down in a contract. Now, I know what you're thinking. This all sounds fantastic, but what's the catch? What does this peace of mind actually cost? Let's walk through a realworld calculation and find out the price of certainty. Okay, let's imagine a scenario. Let's say you own 300 shares of SPY. You know, the big S&P 500 index fund. Your whole position is worth a little over 200 grand. And your goal is super simple. You want to guarantee that no matter what happens, you can't lose more than 30% over the next year. That sets our guaranteed sale price at 480 bucks a share. Okay, so this is our starting line, $26,700. That's the nest egg we're looking to protect. And to get that oneyear rockolid guarantee on the whole thing, here it is. The bill comes to $2,040. That's the total premium you pay upfront for a full year of sleeping soundly at night. But here's where it gets really fascinating. When you put that cost into perspective, 2 grand feels like a chunk of change, but as a slice of your portfolio, it's just under 1%. 0.99% to be exact. So, you're basically paying a 1% annual fee for an ironclad guarantee against a financial catastrophe. And here's how it plays out. Let's say the market absolutely tanks and spy plummets to $300. Doesn't matter to you. You have the contractual right to sell all your shares for $480. Even if it just dips a little to 470, you still get to sell for $480. And what if the market soarses to 900? Fantastic. You can just sell at the market price or hold on for more gains. the only thing you've lost is that 1% premium you paid for insurance you happily didn't need. So this sets up a really clear comparison. We've got two completely different ways to handle risk and each one comes with its own very specific kind of cost. On one side you have put options. The cost is certain. It's explicit. It's right there on the price tag. You pay that roughly 1% premium year in and year out. And in return you get certainty, a hard floor on how much you can lose. On the other side, you have trend following. The cost here is kind of sneaky. It's uncertain and implicit. You pay for it with those whipssaw losses and frankly the emotional stress of false alarms. Now, this isn't to say trend following is just bad, period. The source material points out it can actually work pretty well for things that are less volatile like bonds, but yeah, it really has a tough time with individual stocks. The main takeaway here is that it's not an eitheror decision. you can actually combine these strategies. And that really brings us to the most important question. This isn't about which strategy is technically better. It's about figuring out which cost you personally are more comfortable paying. I mean, this quote from the source material just sums it all up perfectly. There's no free lunch. You are going to pay for downside protection one way or another. The only question is, do you want to pay an explicit bill or do you want to pay with an unpredictable drain on your money and your sanity? So, at the end of the day, it really boils down to your personality as an investor. Would you rather pay a known price about 1% a year to sleep soundly at night knowing your absolute worst case is already defined, or would you rather avoid that fixed cost and in return accept the emotional roller coaster and potential hidden losses that come with a more uncertain strategy? And really, that's the question we want to leave you with. In the world of investing, managing your risk always, always has a price tag. The only choice you have is deciding which one are you more willing to pay.