Wednesday, July 6, 2011

Credit Rating Insurance

When I was in the military, in the Vietnam War, we were taught like this: In planning, never think, "Does this guy want to hurt me?" Instead, think, "In what ways is this guy capable of hurting me."

It's a long way of saying, Plan for the possible, not the likely. Plan for the worst case. Get insurance.

And with the prospect of congressional Republicans forcing a default on U.S. government debt by refusing to raise the debt ceiling, the worst case is in the headlines every day.

I feel a need for insurance.

And here's how I've chosen to do it.

I've bought out-of-the-money September puts on the S&P 500 exchange-traded fund (SPY), with a strike price of $120. This covers me, partially, if the rating agencies lower the U.S. credit rating and the market tanks.

And I've bought out-of-the-money September calls on the gold exchange-traded fund (GLD) with a $164 strike, which covers me in part against the collapse of the U.S. dollar.

Being well out of the money, these calls are dirt cheap. They'll triple in value if the worst case happens. And if the worst case doesn't happen, they're likely to still have enough liquidity so I can mitigate my losses.

April 4 is the debt-ceiling deadline, the Obama folks say, so that will be plenty of time before the options last trading day on Sept. 16.

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