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TheStreet Open House

How to Protect Your Portfolio as Volatility Rises

NEW YORK ( TheStreet) -- With the uncertainty of the fiscal cliff, possible higher tax rates and doubts about the viability of Greece as a member of the EU, volatility is priced relatively cheap right now and could possibly spike.

Although there was a rise in recent weeks, the cash VIX -- an index of volatility -- has so far continued to hold resistance around 19 to 20. My question is: Will it be able to hold this area on additional attempts? I don't think so. To me, the market just appears to be too complacent and that, often times, spells trouble.

Now don't get me wrong. I do not believe VIX to be the holy grail indicator that many think it is. It is far too limiting, and many other factors must be taken into consideration when looking at volatility. That being said, I do believe that volatility has been in the process of carving out a bottom for some time.

Looking at a daily chart, cash VIX has held the 14 area as support on numerous occasions, and I have no reason to believe this will change any time soon. The next few sessions will be very telling about the health of the stock market.

Looking at VIX, we saw volatility get crushed in recent sessions, falling from the 19 resistance area back down to 15-ish. The moving averages had been pointing up on volatility prior to this. So the key question now is: Will cash VIX put in a "higher low" here? If it does, that would be a strong bullish signal.

The other factor to consider is the stock market itself. Looking at the December S&P 500 futures contract, the market is currently battling its 50-day EMA around the 1,403 area. As I penned last week, this is an extremely important technical area that will make or break the rally we have seen in recent days. If it shuts the door to additional stock upside here, look for a swift move lower once again. If the market takes it out, the Santa Claus rally will be on and markets will likely grind higher into year's end.

I cannot see the future any better than you can. All we can do is try to make the appropriate moves at the appropriate times based on price action. What I do think is a smart move is hedging your positions. It has always amazed me how easy it can be to do this, yet I see very few people doing it.

With volatility priced right now at what I believe is a discount, there are many ways to try to hedge a stock portfolio. One example is simply outright put purchases. One can use the S&P 500 futures options or even the mini S&P 500 futures contracts. One can also look at getting long volatility in other ways such as buying VIX futures or calls on VIX.

Now, remember, no hedge is perfect. However, I do believe an investor can substantially limit the downside by taking appropriate measures.

Whichever way the hedge may be accomplished, I really feel that, given everything going on in our world right now, that this is a no-brainer. Assuming straight option purchases are used, the money at risk is limited to the premium paid plus transaction costs.

If the market goes up, you lose on the hedge but gain on the portfolio. If the market tanks, you may potentially profit on the hedge while losing on the portfolio. Trading and investing is all about trade-offs and managing risk. With volatility priced at current levels, how can you afford not to buy some protection? As always, feel free to contact me to discuss your specific situation and we can work together to come up with a trading plan that fits your needs and risk parameters. Please note today is Nov. 27 and all trade data is based on the most recent information.

Futures and options trading is inherently risky and unsuitable for all investors. Past performance is not necessarily indicative of future results. Stop-loss orders intended to limit losses to certain amounts may not be effective because market conditions may make it impossible to execute such orders.

Commodity Futures Trading Commission disclosure for licensed brokers: This material is conveyed as a solicitation for entering into a derivatives transaction.

Matt Zeman is a trader at Kingsview Financial. He began his trading career as a runner in the grain pits at the Chicago Board of Trade before becoming an arbitrage clerk. Eventually he started trading equity options and stocks. Matt now is a full-time futures broker. He has been a frequent guest on CNBC, Fox and Bloomberg, and provides his views on the stock, bond and futures markets for financial media including Dow Jones, the L.A. Times and The Associated Press. Matt is a member of the Chicago Board of Trade, and carries series 3, 7 and 66 licenses.

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