Market Risk

The classic SIE item drops a broad-decline scenario — “a recession sinks the entire market” or “the S&P 500 falls 20%” — then asks how to protect a long stock position. The tell is that the loss has nothing to do with the issuer; once you spot that, rule out “diversify” and “buy more stocks,” since adding equities only loads on more market risk. The credited choice is almost always buy a protective put (hedge one position) or reallocate across asset classes (lower portfolio beta).

Don’t confuse market risk with its systematic sibling inflation (purchasing-power) risk, which erodes the real value of fixed payments and worsens with maturity; market risk is a price drop now. Versus nonsystematic risk (business, financial, credit, liquidity), the dividing line is the diversification test: diversifiable means nonsystematic. A protective put caps downside, but the premium is the cost — unlike a covered call, which cushions only premium-deep (the income received, with no further floor). Memory hook: market risk is the one you share with everyone holding stocks.