How much insurance cover do you have?
I did a stocktake over the weekend. It turns out my family has nine policies. You can add an extra couple if you include indirect cover.
Our insurance covers everything from home to business…life to health. There’s something for everyone.
This level of cover doesn’t come cheap. The combined cost is thousands of dollars annually.
Some may say this is over the top. They could argue the odds of the sky falling in are low. And they would be right. The worst outcome rarely happens.
But sometimes the longshot gets up. This is when insurance pays its way.
You can insure just about anything these days. The key is deciding how far to go.
I have a strategy for making this decision. I call it the ‘what if’ test.
This is how it works. I ask myself what if the worst was to happen. If I’m prepared to live with the financial outcome, I do nothing. But if not, then I insure. It’s as simple as that.
Let me give you an example.
Insuring a six figure bonus
Investment banks have a reputation for paying big bonuses. My former employer — Bankers Trust — was no exception. Six figure bonuses were common. Some were higher still.
My most profitable year at the bank was 1998. A number trades had done very well. And I was on track for the biggest bonus of my career.
But there was a problem.
The markets were on edge. An economic crisis was unfolding in Russia. And it was sending shockwaves around the world. There was a real fear stock markets could fall hard.
Rumours were circulating that my employer was in financial trouble. A number of big bets on emerging markets had gone south. There was a sense that the bank may not see out the year.
The collapse of a high profile hedge fund didn’t help. This put extra pressure on a shaky situation. My concern was the bank would go under if the markets sold off. That would be end of my bonus.
Insurance companies will give you cover for many things. Unfortunately, bonus cover is not one of them. I had to tailor my own insurance package.
So I got creative. I bought put options on high priced stocks. The logic was that if the markets crashed, my put options would rise in value — and cover the likely loss of my bonus.
It was an imperfect hedge. But it was better than nothing. For a few thousand dollars, I had a lot of protection if stocks took a dive.
Well, a crash didn’t eventuate. Bankers Trust made it through the year. And I got my bonus.
The options were a write-off…they expired worthless. But that’s okay. It’s a good year when you don’t need a payout on your insurance.
But my fears were real. My employer didn’t last much longer. Deutsche Bank took it over the following year.
Insurance is a key strategy for managing risk. It’s your backstop for when things don’t go to plan.
Quant Trader has two inbuilt insurance mechanisms. The first is the exit stop. Think of this as basic cover. It gets you out when a stock falls. The money you lose is effectively your insurance excess.
The next level of cover is more exotic…and it isn’t for everyone. This is short selling. The aim is to make money when the market falls. This should act as a buffer for losses on long trades.
The numbers that count
Last week you saw the performance of long trades. Now I’ll look at the shorts. This will give you a clear picture of how Quant Trader’s insurance strategy is tracking.
But first, have a look at the following chart. It’s the All Ordinaries over the period Quant Trader has been giving live signals…
There are three distinct periods:
- Stocks sell-off into mid December
- There is a strong rally into the April high
- A five month (and counting) correction kicks in
Now check out the performance of Quant Trader’s short trades.
This shows the hypothetical performance of Quant Trader’s short signals. It assumes $1,000 on every short signal. There is no allowance for costs.
Again, you can see the three periods. The insurance policies are working hard in periods 1 and 3. This takes the pressure off losses from long trades.
Period 2 shows a loss. This is when the market is rallying. Shorts will typically be a drag on performance during these times. That’s the price of insurance.
Let me say that Quant Trader is not a standalone strategy for trading short. The system makes most of its profit through buying shares. So don’t worry if you’re not comfortable with shorts.
But shorting is a worthwhile strategy for some traders. It takes the edge off down periods. This tends to smooth out performance over time.
Most people insure their car and house. A large majority also have private health cover. But fewer people think about cover for their share portfolios.
Insurance isn’t a free ride. I’ve paid much more in premiums than I’ve collected over the years. And that’s a good thing. Insurance is a plan for the worst. It’s something I hope not to call upon.
Until next week,
Editor’s note: If you don’t know which stocks to short, then Quant Trader can help. The system’s algorithms are constantly scanning the market for vulnerable stocks. It will then issue a sell signal, and calculate a unique stop loss.
Just a few days ago, Quant Trader identified a high profile opportunity. This stock was a shining star of the bull market. Its shares soared by over 300%. But now the trend is lower. This market heavyweight has potentially a long way to fall. There is still time to get short…but hurry.
You can learn more about Quant Trader here.