Over the past decade or so, I’ve had a meaningful hedge position in my portfolio a little more than half the time, mostly because the cost of hedging has been too high (and because I don’t hedge at times when I’m not worried about the valuation of the broad market).

Right now, as we chug through earnings season with generally good news from most of the big companies, the VIX is down to its lowest level since the COVID pandemic began in early 2020, and that means put option pricing is relatively affordable… and that pricing, combined with the fact that the market is back within whispering distance of the all-time highs reached at the peak of speculative mania 18 months ago, helped to push me over the edge to add a new hedge position to my portfolio today.

I should start with a caveat: I hope the unpredictable nature of the future is obvious to you, but I don’t know what will happen to the stock market over the next year. I think we are very likely to see below-average returns over the next decade, just because the overall market is trading at an above-average valuation (and near an extreme valuation, by some measures), but you can’t really effectively hedge a decade. I think the risk of a crash (a drop of 20-30% or much more) is higher at these valuations than it has been at other times… but those are just probabilities, leavened with opinion and a view of stock market history, none of which gives us any certainty about what the next 6-12 months will bring. The overall stock market could double this year, or we could be faced with a “black swan” event that causes a 60% crash in stock prices, or, more likely, we’ll muddle along somewhere in between those extremes.

But investor sentiment is back to pretty strong optimism — the “Fear and Greed Index” published by CNN has been at “extreme greed” for a month or so, driven by a strong market, enthusiasm over AI stocks and other “growth” stories, and the expectation that the Fed will soon stop raising interest rates and provide a “soft landing,” slowing the economy without causing a recession. And that’s both making me nervous, as we inch back up to peak valuations again, and creating the opportunity to hedge at a relatively reasonable price, as ...