The hidden cost of 'always-on' crash insurance
Continuous protection sounds prudent until you account for the bleed. A framework for thinking about protection budgets.
Permanent hedging feels smart until it doesn't
I've had this conversation many times. Someone comes in, they've been buying monthly puts for two years straight, and they want to know why their portfolio is underperforming by double digits. The answer is sitting right there in their trade blotter.
The pitch is always the same: crashes are unpredictable, so stay protected all the time. Buy puts every month, roll them forward, keep a constant downside buffer. Clean logic. Brutal economics.
What the bleed actually looks like
Run the numbers on a basic program. 5% OTM puts, 30 DTE, rolled monthly.
In a year where nothing terrible happens, you're burning 3-5% of portfolio value on premium that expires worthless. Stretch that out five years and you've lit 15-25% of your book on fire.
Deductible choice is the cost engine
The question is not simply whether insurance is expensive. It is which deductible you are choosing and which class of drawdown you are paying to insure.
Your protection only "works" if the drawdown is catastrophic enough to offset years of bleeding theta. A 15% correction won't do it. You probably need something north of 30% before the math flips, and even then the timing has to cooperate. Most people running these programs haven't actually done this arithmetic.
Break-even depends on path shape, not only magnitude
A 30% decline reached in weeks behaves nothing like a 25% leak over months. The path determines how much of the premium burn the hedge can realistically recover.
A different framing
People keep asking "should I hedge?" Wrong question.
Budget-based approaches are one option: pick a number, say 1.5% a year, and deploy it when conditions warrant. Vol's cheap, credit spreads are tight, macro's deteriorating. You won't catch every crash but you'll keep more of your returns.
Trigger-based works too. Define entry conditions (VIX below 15, IG spreads inside 100bps, whatever your framework says constitutes complacency) and load up when they're met.
Or go structural. Spreads and ratios carry less but they cap your upside on the hedge. Tradeoffs everywhere.
None of these look great in hindsight. They all force you to state what you actually believe, which is probably the real value.
The real question
"What am I willing to pay for protection, and under what conditions?"
Continuous insurance answers this by default: whatever it costs, forever. That's a position. Most people holding it don't realize they've taken it.
Before committing
- Run the 5-year cumulative cost assuming no crash materializes
- Figure out what severity of crash justifies that drag
- Stress-test whether trigger-based entry gets you most of the protection at a fraction of the cost
You're making a bet either way. On crash frequency and severity, on your ability to time entry, on your tolerance for being wrong. Better to make that bet explicitly than back into it through autopilot hedging.
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Philosophical note for veriolab.com. Educational only. Not investment advice. Verio Labs provides modeling, analytics, and evaluation. We do not manage assets or give trade recommendations. See our Disclosures.