Here we go. Gold and silver are soaring, financial stocks are tanking, heads are rolling on Wall Street, and the Fed’s creditability is melting like a popsicle on a hot summer sidewalk. This is very bad for most of the world, but a once-in-a-lifetime party for the handful of people who put themselves on the right side of these trends by loading up on gold and shorting the banks and brokers. If you’re one of them, nicely done!

But the ride’s not over. Now you have the problem everyone else wants: Massive paper profits that have to be protected in a market that’s all but guaranteed to throw some nasty curves your way. Sure, gold is eventually going to $2,000 and Merrill and Citi to $10 or so. But in the meantime, the Fed will, without doubt, announce a surprise rate cut that sends financial stocks up 30% in a day. And the world’s central banks will—guaranteed—dump hundreds of tons of gold on the market one of these nights, igniting a wave of panic selling when the U.S. markets open. And they might do either or both very soon. So if you’re long the miners and short the banks, what do you do?

Possibility number one is the best but the hardest: Just sit tight and trust that fundamentals like excess money creation and festering bad loans on bank balance sheets will win out over corruption and manipulation. Five years from now you’ll be rich and the coming year’s gyrations will be barely-noticeable squiggles on gorgeous long-term charts. Still, the kind of emotional maturity required to stoically let big gains melt away, even temporarily, is as rare as it is admirable.  

Strategy number two is to sell now, book your gains, and wait for a new entry point. This, like all forms of market timing, is a great idea if you can pull it off, but a disastrous one if you’re on the sidelines when Goldman Sachs announces that, upon further reflection it does indeed have a few hundred billion in subprime/derivatives/CDO losses to report. Plus, taking profits means paying taxes to the current government, which it’s safe to assume you really don’t want to do.

The third way is to hedge. Keep your positions, but use options to limit your volatility for a while. For how to do this right, I checked in with Bill Lambert, head of AMC Advisors, a good friend who specializes in this kind of thing for his clients. He likes the idea of hedging right about now. “Nothing goes up in a straight line, and precious metals and financial puts are due for a correction.” The solution? “Easy. You just do a collar.”

A collar is a relatively simple strategy (compared to a lot of the spreads and straddles that Bill sometimes tries to explain to me) that involves buying and/or selling both a put and a call to lock in a given price for an underlying security at minimal cost. All prices in the following examples are more or less market quotes from November 7.

Say, for instance, that you’re short 1,000 shares of Merrill Lynch (MER), via 10 LEAPS put contracts expiring in 2009, and Merrill is currently trading at $55. To apply a collar:

• Buy 10 December 55 call contracts (each of which represents 100 shares of stock) for $3.80, or a total of $3,800. This gives you the right to buy 1000 shares of Merrill at $55, a right which becomes more valuable if the stock goes up. • Sell 10 December 55 put contracts for $4.10, or $4,100. This gives someone else the right to force you to buy 1,000 shares for $55, an obligation that becomes more expensive for you if the stock goes down.

“Since the put you’re selling trades at a slightly higher price than the call you’re buying, you get a credit of $300,” says Bill. So your commissions are more or less covered up front.

Now let’s say Merrill pops to $65. Your LEAPS puts go down by around $10,000 (assuming for the sake of simplicity that they move dollar for dollar with the share price) while your calls go up by about the same amount (the difference between the $55 strike price and the $65 stock price). The puts you’ve sold expire worthless, so you break even overall.

If, on the other hand, Merrill keeps falling, your call expires worthless, your LEAPS puts go up in value and the short term puts you’ve sold move by an equal and opposite amount. The result is that either way, “For the duration of the December options you’ve more or less locked in your current price,” says Bill.

Now let’s say you own 1,000 shares of Goldcorp (GG), which has run from $21 to $37 in the past year. To collar it:

• Sell 10 December 35 call contracts for $2,650. This gives someone else the right to buy 1,000 shares from you at $35. • Buy 10 December 35 put contracts for $2,050. This gives you the right to sell, or “put” 1,000 shares to someone else for $35. You collect the difference of $600.

If Goldcorp drops to $25, your shares fall by about $10,000, the call you’ve sold expires worthless, and the puts you own go up by about $10,000. The value of your position doesn’t change, and you keep the collar premium. In December, the collar expires and you’re free once again to profit from gold’s long run. “This is a classic collar, really sweet,” says Bill.