Using a stock index option to hedge an equity portfolio

Options can be used to hedge against individual stocks, but if you have an entire portfolio of stocks, buying options on each stock can be both tricky and expensive in terms of commissions paid and time wasted. An article from the April 1st issue of Futures Magazine (found here) explains that a simpler and more cost effective way to accomplish this hedge is to first find an appropriate proxy index using statistical correlation analysis based on the basket of securities in your portfolio, and then purchase puts for that index alone. The effect is not a perfect hedge, but the savings with the cheaper insurance and the correlation between the basket and the index should protect you from taking a huge hit if the market falls significantly.

In the below table, the author gives a simple example based on six randomly selected stocks. He compares the costs and benefits of buying a put on each stock individually versus buying a single put on the S&P 100 index (OEX). Even though this is a very simplified example, you can see the effect: the two methods protect about the same amount of investment, but the index option comes at a lower cost. 

The below video takes this idea a step further. The expert agrees with the above strategy, but also says a more modern means of achieving the same result is to buy calls of VIX (and index that increases in value as volatility in the market increases):