Cboe Global Markets

Hedging Portfolio Risk with Mini-SPX Index Options

February 11, 2021

So, you’ve finally built your portfolio just the way you want it. You’ve done the research and identified the stocks and/or exchange-traded funds (ETFs) you want to hold. Now, it’s just a matter of letting things unfold and watching your capital grow over time.

And then, just like that, you see an event you’d like to hedge against. Maybe you’re concerned about a market correction, or maybe you suspect something worse. In any event, if you were a typical stock investor, you’d be faced with a difficult choice: sell some stocks or ride out the decline? 

If you decide to sell stocks, you must first decide which stocks and how much of each to sell. Then you face tax implications and, ultimately, the need to make another decision down the road regarding when to go back to being fully invested. Still, if you decide to “ride it out,” you face suffering through the angst and financial hit that can come if things get worse than you expected. Fortunately, as a more flexible stock investor, you can hedge your entire portfolio with a single transaction using index options, like Mini-S&P 500 (SPX) options, which go by the ticker XSP.

It’s Like Insurance for Your Portfolio

When you buy a put option to hedge an existing portfolio, it’s a lot like buying an insurance policy. You pay a certain amount of premium to cover a certain amount of potential loss during the life of the “contract.” Regardless of what happens during the life of the hedge, your stock portfolio remains intact—no need to sell individual shares and no tax implications from a sale. If the market advances while you hold the hedge, you may be out some or all of the cost of the put option. But that’s the nature of insurance.

Hedging an Entire Portfolio with One Transaction

Buying a put option on a stock index such as the S&P 500 Index (SPX) allows you to profit from a decline in the overall stock market. One problem with doing this: Options on SPX can be expensive to buy, as each contract has a notional value of $100 times the index. With an SPX of 3700 (as of December 2020) that’s a notional amount of $370,000—far exceeding the hedge value for many investors.  

The Cboe Mini-SPX Index options, on the other hand, are 1/10 the value of the SPX options (or a notional amount of $37,000), so Mini-SPX could be an affordable—and more appropriately sized—alternative.

What size hedge might you need? Consider these three questions:

  • How much adverse price movement do you want to hedge against?
  • How much of your portfolio do you want to hedge?
  • How much are you willing to spend to hedge your portfolio?

As a bonus question, you might want to consider your portfolio’s beta—the amount it’s expected to move for any 1% move in the SPX. Most portfolio tracker software can help you determine beta. Or you can eyeball it by looking at the individual betas of your largest holdings. A portfolio beta is simply the sum of each component’s beta times its weighting in your portfolio.  

Trying to decide which strike price to buy? Remember this trade-off:

  • The higher the put’s strike price, the more downside protection you get—but the higher the price you pay for the put
  • The lower the put’s strike price, the less downside protection you get—but the lower the price you pay for the put

When it comes to deciding how many options to buy of a given strike price, remember this trade-off:

  • The higher the number of put options you buy, the more of your overall portfolio you hedge—but the higher the cost
  • The lower the number of put options you buy, the less of your overall portfolio you hedge—but the lower the cost

When going through this exercise, remember too that the longer you wish to hold a hedge—all else equal—the more it will cost. So if you have a fixed amount of money you’re willing to spend on a hedge, you might need to trade off between time and the amount of portfolio coverage.  

Here’s an Example

Say you have a stock portfolio worth $35,000 and you’re concerned that a 10% to 20% correction could occur within the next three months.

With the XSP index valued at $370, you might consider buying one 370-strike XSP put option with three months left until expiration, and let’s say it’s currently trading for $16.00 per option. To put on this hedge, you’d pay $1,600.

So, what happens if your fears are met and the stock market declines 10% by option expiration? 

  • The XSP index declines 10% from 370 to 333
  • If your portfolio also declines 10% in value, then it would decline by –$3,500
  • The intrinsic value of the 370 put (the difference between the strike price and the index) increases from $16 to $37—a gain of +$2,100 on the hedge

At option expiration, you still have your entire stock portfolio intact and your net loss at that point is only –$1,400 instead of –$3,500 if you hadn’t bought the put as a hedge.

Now consider an even more extreme scenario. Let’s say the stock market plunges a full 20% in value in three months’ time.

  • XSP index declines 20%, from 370 to 296
  • Say your portfolio also declines 20% in value, or –$7,000
  • The intrinsic value of the 370 put increases from $16 to $74 for a gain on the hedge of +$5,800

At option expiration, you still have your entire stock portfolio intact and your net loss at that point is only –$1,200 instead of –$7,000 if you hadn’t bought the put as a hedge.

The Bottom Line

This exercise merely scratches the surface, but you get the idea.  

Mini-SPX options offer you a way to hedge your entire stock portfolio in times of uncertainty without having to sell your individual stock holdings. You just have to decide when you want to “buy the insurance” and “how much insurance you want to buy.” For that, there’s no right or wrong answer. It depends on your views—how strongly you believe a hedge is needed—as well as your risk tolerance level and overall investment objectives.   

There’s an old Wall Street adage: Sometimes it’s about return on capital; other times it’s about return of capital. Hedging is about those times when capital preservation is the name of the game.


*Under section 1256 of the Tax Code, profit and loss on transactions in certain exchange-traded options, including XSP, are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will be taxed. Tax laws and regulations change from time to time and may be subject to varying interpretations.

Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of “Characteristics and Risks of Standardized Options.” Copies are available from your broker or from The Options Clearing Corporation at 125 South Franklin Street, Suite 1200, Chicago, IL 60606 or at www.theocc.com.

Past performance is not indicative of futures results. The information in this article is provided for general education and information purposes only. No statement(s) within this article should be construed as a recommendation to buy or sell a security or to provide investment advice. Supporting documentation for any claims, comparisons, statistics or other technical data in this article is available by contacting Cboe Global Markets at cboe.com/contact.

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