Alexandre Dumas said, "All human wisdom is summed up in two words - wait and hope."
It is my guess that, today, he wouldn't be a very successful investor.
Over the last month we've seen a big drop in risk assets. There are plenty of investors saying "I should have....If only....Who knew....I shouldn't have waited....etc".
Most investors are familiar with only a few "long term plans", such as "Dollar-Cost-Averaging" and "Portfolio Rebalancing". These are easy to understand and implement but don't really address the uncertainty of a dual market direction. I have written extensively on strategies designed to work in up and down markets and I would like to pull some of them together to help the reader with today's market.
I started January with my "What me Worry?"Article. I encourage readers to review it and consider bringing those concepts forward. Last month one reader asked how it fared. As of that date, the SPDR S&P500 ETF (SPY) was up slightly over 11% and I responded that "What me Worry" was up slightly over 9%. So it trailed a little. However, this strategy was predicated on making money in either market direction. Well, just one month later, the SPY is now flat for the year and this strategy remains up over 7%.
In early May I wrote an article detailing my reasons for selling near month ATM naked calls on the SPY. In just two months it is up almost 5%.
Now, with the NAKED CALL strategy, if SPY bounces, I'll give back some of these gains, but that's fine with me. After all, this strategy is designed for gains on a flat or down market and "break-even" on an up-market.
A common denominator for both these strategies is that they are designed to be ongoing, continual plays. They can be blended in to a portfolio in much the same way that Dollar-Cost-averaging is. That is, just do it every month and have confidence that it will work. If not in the short term, then certainly over time.
Most importantly, they are not "take a bite" strategies, but designed to be implemented at significant levels in relation to the overall portfolio. In this regard, they have contributed, not only good percentage returns, but quite significant dollar returns. After all, I still haven't figured out how to spend "percentages", but have no problem spending dollars !
So, what to do now? In this article I'll deal with a simple hedge as a defensive posture. For those looking to take advantage of the recent pull-back, my next article will explore some offensive postures.
First, market volatility is high and that favors selling options. So, I'd rather sell calls than buy puts. In April, when the vix was at 16, THAT was the time to buy puts.
Second, there is still a lot of uncertainty and many investors, those that didn't sell at SPY=$140, are waiting for a bounce to sell (see Alexandre Dumas). I think this caps SPY in the near term.
If market factors straighten out, SPY could climb 10% (or more) by year end. So, SPY=$140 is still on the table. Selling an OTM NAKED call, December 22 expiry, at a strike of $135, will credit about $5.00.
If SPY lands on the December expiry below $140 it makes money. The further it misses, the more it makes. If SPY never recovers above $135, I've added about 4% to my portfolio.
If SPY exceeds $140, then it self-converts to selling near term ATM NAKED calls in accordance with the strategy. Eventually, I expect it to break even if the market rockets up.
Though this strategy is self fulfilling, I'm employing it IN ADDITION TO selling near-month ATM calls on SPY. If, over the next few months, SPY has risen by a decent amount, I can suspend the near-month ATM sales in favor of just holding the December naked call. But, I'll cross that bridge when, and if, it comes. I'd rather take action and adjust than simply "wait and hope."
Additional disclosure: I buy and sell calls and puts on SPY