Vacation-Proofing Your Portfolio

When driving a car and some object appears on the road ahead, do you usually run right over it or do your best to avoid it? Don’t we all take action in real life based on the new information we receive that changes the old paradigm? 

Take the first two guys in this video: Who would you rather be, the first or the second guy? While the second gentleman reacts and looks ridiculous in so doing, he’s the guy that is more likely to survive when real disaster hits because he’s reacting to new information. In fact he doesn’t even know what’s making everyone else react, he just knows that when 99% are moving one way in panic, it’s best not to fight the crowd or he will be trampled. It’s no different in the market. Pride, ego and old theses have no place when new information directly contradicts an existing trade.

When the market is up, we use DIA puts and calls to "react" to quick changes in the market while we wait for better information before making more permanent changes in our positions.  This gave us the benefit of the quick reaction of gentleman #2, the one who went unquestioningly with the crowd, while also giving us the "wisdom" of gentleman #1, who was confident (or oblivious) enough to soldier onward, despite the fact that the world seemed briefly to be against him.

When new information does arrive, one of the first things I look to do is minimize risk - hedging the existing position. The next step for me is to become more aggressive in reacting to the new information and shifting the bias of the trade in the opposite direction. In this article, I will outline our basic strategy for protecting your portfolio from a major dip, which can then be used to adjust your risk profile, based on changes in outlook arising from new information. 

The strategy outlined can be applied also when you know that you will be unable to monitor your positions.  Many of you will likely be taking vacations this summer and, with them, a break from actively monitoring your positions. With that in mind, it’s always prudent to protect your positions from the “just in case” events that can derail your positions in a flash when you are not attending to them. Those “just in case” events are a reason to remain nimble and flexible when trading the stock market as opposed to becoming emotionally tied to any single position.

We have published this article before with many individual strategies but, today, we will focus specifically on the DIA puts, which are the cornerstone of our "mattress plays."  Keep in mind, the point is not to "win" these trades; the idea is to bet against yourself, putting your folder in "neutral" while you head off to the Bahamas for 2 weeks or just off to the Hamptons for the weekend.  You may lose time value on both ends of your trade but often this is less than the cost of jumping in and out of positions.  You paid for your vacation - adding a hedge is just another travel cost that lets you really enjoy it without worrying about your portfolio!

I use the DIA’s because the Dow is always in your face, even when you are away, so it’s very easy to keep track of in case you need to make an emergency call to your broker - but the logic works for any of the indices.  If you are heavy in technology shares, you can purchase QQQQ puts etc. but I find the DIA puts to be excellent overall portfolio coverage.  When I am more actively trading, I may focus on the index that is likely to snap back the most on a correction which is another great way to insure your positions and often more profitable (assuming you are good at doing your homework).

Remember, this is about buying INSURANCE, protection against a catastrophe.  Much like life insurance, this should be considered the cost of keeping your bullish portfolio alive and healthy, even in a downturn.  Also, much like life insurance, it sucks when you collect!  You need to go into these plays knowing what kind of drop are you worried about.  You need to look at how well covered you are now and (yesterday being a good example as we did drop 300 points) get a handle on the danger you face in a 300 point drop and think about the value of that kind of insurance. 

As with any spread, it’s a relative gain issue.  There is virtually no point to having two contracts at the same strike a month apart as you will have no particular advantage over the short position (putter) on a drop.  Rather than write a book on the subject, let’s just take the best current protection at this exact spot, even though I currently do not have DIA puts as I am waiting for 11,800 to put them on.  I was fully covered and too deep in the money yesterday after the run-up so there was no point in the puts, I am now 1/2 covered (we took off callers we were 50% or more ahead on) and may add DIAs today rather than cover up over the weekend as I don’t want to get buried in another pop so let’s say we end today in the same spot and I took a $20K hit yesterday but now I’m half naked so I’m worried about a $30K hit if we drop 300 more on Monday.

Rule number one in selecting an index put is to have at least 45 days, because you want to be somewhat insulated by the time of the spread and, most importantly, you want to be able to sell front-month puts (short) against your position.  We could take September, but at this point I’d rather see October.  Generally, our rule with an index put is that we will roll up to the next $1 strike (higher for a put) for .40, as we are buying $1 in position for 40 cents.  Since it’s 11 weeks away, rather than look for rolls at .40, I’m going to look to roll up $1 for .50 so, logically, the position I choose is the first position that can NOT be rolled up for .50 or less, that would be the Oct $117 puts at $6.38 as the $116 puts are $5.85 (-.53) and the $118 puts are $6.97 (+.59).  More importantly, the $119 puts are $7.60 (+$1.22), the $120 puts are $8.23 (+$1.85) and the $121 puts are $8.93 (+$2.55) so a 400 point drop will net me $2.55 profit and a 300 point drop will net me $1.85 off the Oct $117s.

Assuming roughly a $2 gain, if I want to cover 1/2 of my projected $30,000 loss of a 300-point drop, then I need 75 contracts. But let’s say we are a little more nervous and take 100 for for $63,800.  On the downside, a 300-point gain will drop me to (approximately) the level of the Oct $114 puts and they are $4.88 (down $1.50) so I will lose $15,000 on a run up.  Since I lost $20,000 on the way down I can assume I’ll make $20,000 on the way back up (probably better as I am now 1/2 uncovered, but let’s be conservative) so getting my portfolio back to even on a 300-point run up will cost me $15,000.  Just like life insurance, you don’t want to be over- or under-covered. 

Now I can look to offset that $15,000 loss by covering my long puts with current puts.  Question 1:  How low do I think the Dow can go?  Let’s say I’m pretty sure 10,800 will hold (500 points down).  My main goal of protection is my worry about a drop to 11,000 even and the Aug $111 puts just so happen to be $1.44, which is almost exactly what I would lose on my longs if we head up 300 points!  Also, since my Oct $117 puts have $3 in premium with 3 months left (about) this $1.44 will more than cover my premium loss for the month so also perfect! 

If the Dow goes up 300, I get my $20,000+ back on my main positions and remain neutral with my puts.  As the value of the August puts I sold decreases, I "invest" that money into rolling myself up to higher stikes on the long puts following the rule of spending .50 to gain $1 in position.  This will require some additional investment in the October puts as the front-month puts will only lose about .30 per 100-point move against them.  Still, that nets out to me spending .20 per $1 of protection on the way up.  Once my short putter is not returning .30 per 100 point Dow gain, it is time to roll him to a higher strike (following the same rule of thumb - what kind of drop do I fear from the new Dow level?).

So, ideally, if the Dow were to gain 300 points next week to 11,650, I will have spent $1.50 to roll my Oct $117 puts to the Oct $120 puts and would have moved my putter up to the $115 puts for another .70.  That means I have now collected $2.14 by selling puts against my now $7.88 position in the October DIA $120 puts.  Now the Dow can drop 500 full points before I owe my putter a penny and my portfolio is now protected by October puts that are $3.50 in the money that I spent a net of $5.74 on, not bad!  Of course as time goes on this gets more complex and that’s why we teach it month after month but, for a vacation of less than a month, it’s not too much of an issue…

If the Dow goes down 300, my puts gain $20,000, offsetting 2/3 of my probable losses AND it’s still not enough to put my putter in the money (and he can be rolled down to the Sept $106 puts even anyway, which is why it’s nice to have an extra month between you).  The more the Dow goes down, the more my long puts gain per 100 points and, since I can roll the August puts to September (and even, ultimately, to October to create a vertical bear put spread) I can state with fair certaintly that my spread can be managed through an 800-point drop, although preferably not on one day! 

A lot of our older members have learned this technique as we practiced it over the years, and through several harsh market corrections.  Having long puts in place as protection allows us to leverage our puts into mattress plays, which can actually turn a nice profit during a severe dip.  It was nice to see the generally calm attitude of our group during member chat yesterday as we were well covered and able to watch the drop making minor adjustments, rather than screaming for the exits. 

Market dips should be buying opportunities, not gut-wrenching tragedies and balancing your portfolio is a good idea any time.  Learning to use these techniques will allow you to shift your portfolio from bullish to bearish to neutral almost at will.  We will be establishing DIA puts, usually held in the Short-Term Portfolio, directly in our Long-Term Portfolio and will be spending more time on this technique this year as the tremendous volatility of the market makes it more important than ever for us to manage our risk appropriately.

Trade safely!

Comments

[fxtrader07]

i don't get it. if you are to go on vacation you simply examine your portfolio. are there stocks that could be hurt by an earnins release during that time? any stocks very vulnerable to pending, long awaited announcements? if so, sell them. dow puts won't protect you from company specific risk.
now, for the other stocks: if you picked them wisely, you need not time overall market swings. you could still use djia puts as some sort of alpha-trade (best of tow) but this would hjave nothing to do with going on vacation or not. otherwise, your portfolio is fine and it may take a hit, yes? so what? when you bought the stuff you had figured that possibility in, no? if not, then you didn't know what you were doing in the first place.
imho, if you have conviction regarding your stock portfolio, you NEVER need index puts. chances are, you will be throwing money away for nothing.

[Sheherazade]

Having followed Mr. Davis on Seeking Alpha for quite some time and making money following his trades I took the plunge on Tuesday and began following his $10KXtreme Portfolio. The trades I and many other members took were very clearly indicated and easy to follow:


5 RIMM August $125 calls, entered at $1.80 sold at $2.96. +64%
10 QQQQ September $46 calls, entered at $1.35, still open at $1.45. +7%
10 HOV September $7.50 calls, entered at $1, still open at .90. -10%
10 GOOG August $520 calls, entered at $2.40, still open at $2.80. +16%

This is far better than I usually do in 3 days or even a month and other members are playing a more complex butterfly strategy that is over my head but I am anxious to learn. Clearly from the previous post where you attacked Mr. Davis he is not interested in responding to you but I take offense as your rantings almost stopped me from signing up Tuesday and would have caused me to miss a truly exciting experience.

The message board on the site is full of compliments and here are some member comments from today with names omitted as it's not my place to post them here:

10:15 - "In on WM stock at $3.75. Filled the short collar at $1.65. Better than 50% return in 3 weeks if it finishes above $4. If not, take the stock put to me & try again in Sept."


10:30 - "Phil
It took awhile but managed to move my GS calls and callers up 10 in th eaug and oct . today just moved my oct 170 calls to jan 180 for .20. seems like a cheap move to get 3 months more premium. My rolls up were for even so this is a good lesson on waiting and be patient. Not all of one’s calls/callers will be profitable but it is hoiw you can hang in there to give you an advantaged."


10:53 - "HOV - Took the 33% gain on balance of 7.5’s @.60. Order in for Sept 7.5’s @ .90. Mr. Davis has set the price. 8-)"


11:49 - "Phil,What about uncovering financials in the LTP? I have 40% gain on callers and I think if oil stays down the fnancials will go up."


12:38 - "Phil, hopefuly I’m not being a pest, but WFR calls are up around 20% since you said to buy them yesterday. Any thoughts? Thx."

1:03 - "Weah USO failing the beaf flag! Keep going! BKX -.18% VIX 22.39 We might have a pretty close if this holds on."

1:21 - "Phil - You are now referred to, in my household, as "The Lord of the Fly’s" They are absolutely terrific! Thanks"


2:46 - "Phil- PCX up over 10% today- time to get short again?"

3:31 - "WM Just took a flyer: Sold 6 Aug 4 Puts for .71 and bought 2 Jan 10 5s for 1.95. Two trades combined netted $28 in my pocket and if WAMU doesn’t go bankrupt before Aug expiration I’m probably free-rolling."

4:05 - "BIDU - thanks phil, I was trying to participate if they at least retraced like goog and aapl. Somehow I don’t see them continuing to fly up, maybe an island like goog had a while back. In any case, I moved to sep330 puts and sold aug300 against them for a bit of protection so I think I’m ok for the weekend."

4:19 - "USO- what a great week…been a long time in the making (started getting short at crude 120ish) and i thank phil for the excellent oil piece a few weeks back when i was really reassessing my conviction while comparing oil futures to miami condos…u the man, phil."

9:53 - "A couple times this last week I couldn’t bring myself to hold onto a position any longer when it was up 30-40% or more. Once it hit 30%, I was pretty much putting a 5% trailing stop order in to lock in at least 25%. Google was one where I ended up making 45% on the trade, but I think you made 80% or more. "

There are hundreds of comments today and, as near as I can tell, Mr. Davis answers every single one that asks a question of him. Who have you helped today Contender? Certainly no one who you are working so hard to steer away from what is by far the best service I have ever invested in.

And if you want to check the perfomance, there are hundreds of picks from his posts right here on Seeking Alpha, why not create a scorecard the way people track Jim Cramer? Following those picks is what led me to become a member on the site so there is your first testimonial from a very happy member.


ps. As near as I can tell there is no such thing as a closed thread, all posts and comments on posts appear in the archives going back to 2006. Also, Happy Trading is a rival site which I have also tried, not part of Phil's Stock World.

[BSchecker]

Phil- Stalker far from it. Just trying to get you to mention some of the losing trades also.
APPL and GOOG both got trashed on earnings but gave you credit for sticking with them instead of bailing.
TXN, SNDK, WFR, CROX- all got destroyed by earnings but no mention by Phil on these losing trades.


Sheherazade-Know your facts please.

[Philip Davis]

Hopefully, BS, you are not, as has been rumored, a CNBC worker and someone who is genuinely concerned so let's discuss the trades you mention as if you can pick 4 of 200 open positions we're tracking as representative of our work:

SNDK - As we shut the STP down last week (too risky the way earnings were looking), we had no active position in SNDK into earnings on Monday. The last time my position on SNDK was asked by a member was this exchange:

rahul

Phil - Would you be a buyer of SNDK at these levels? Do you see any catalyst to reverse it’s downward trend? I believe it’s trading below book value and PEG at ~1. Jul 1, 11:45 AM

Phil


SNDK/Rahul - I would accumulate very long positions but this market is starting to look bottomless. Jul 1, 11:58 AM

As there was not a single member mention of SNDK between that day and July 22nd, I guess we can assume it wasn't a big holding.


TXN: Going into the weekend, our position (as always published in the portfolio section for members) was the Jan $27.50s at a basis of $2.87 that we have held since 12/29 fully covered with the Aug $27.50 calls at $1.50

This was an adjustment ahead of 7/21 earnings as we got nervous and covered more but the last exchange on the subject was:

Alex

Phil I covered TXN with the Aug 27.5 will sell half before earning. You would go naked?
hope my BA Jul 65 cover will be zero at friday.
I´ll stick to my C half cover till you say that is not good because C will shoot up like WFC
PEP no cover, waiting till tomorrow like you said Jul 16, 11:39 AM


Phil


TXN/Alex - The Aug $27.50s just went from .85 yesterday to $1.60, the correct thing to do is 1/2 cover no matter how bullish you are and set a stop to cover the rest at $1.20 if it heads down (then with tight stops since your average cover will be $1.40 with the calls at $1.20 so you can buy back half at $1.40 even if it goes back up on you).


The Jan $27.50s dropped to .95 and the Aug calls are, of course, wiped out leaving our Long-Term position with a net $1.37 basis and down 28%. At the moment we are sitting tight but we'll be rolling down to the 2010 $25s at $3.60 at a cost of $2.23 and that will give us just 18 more months to make up the missing .42 selling premiums like the Sept $27.50s at .20 already (but we'll wait and hope to sell for .50+ and, if we don't get to that level by the end of July, we'll probably take the .20 because 18 x .20 is $3.60 and that's more than the entire cost of our leap).


WFR: Those we got killed on, we had the Aug $55s in our Day Trading Portfolio and the Jan $50s at a basis of $10.95 (held since 2/15) in our Long-Term Portfolio, fully covered by the Aug $55s at $3, sold on the 16th and the 21st. We also had the Aug $55s in our $10K Portfolio and the $25K Portfolio as of last Sunday.

As it was a popular holding there were many exchanges but we shut down the $10KP over the weekend and eliminated that holding and these were the relevant comments before earnings:


Marek

Phil - I have some WFR Jan 55 uncovered. With earnings on Wed - how would you cover it? Jul 21, 1:53 PM


Phil

WFR/Marek - All covers should be visible in LTP under portfolios. WFR is fully covered with $55s at $3 as that was just too much premium to turn down. I do like them a lot. Jul 21, 2:07 PM


contingent

Phil in the old 10kp I have WFR 55s. Are you wanting to hold these through earnings? I know you like them, but is there a move we ought to be considering? Jul 22, 10:09 AM

Phil

WFR/Contingent - I’m thinking them over as they may not be worth the risk anymore. The only reason they are still worth $2.45 is because of earnings and risking $2,450 (or 1/2 in $10KP) is not advisable after the SNDK debacle. I didn’t want to sell on the morning dip but we’ll have to watch them closely to see how they do today. I’d say at $3 take the money and run. XXX
Jul 22, 10:29 AM


(XXX by the way is our system for calling all members attention to a comment I consider important to everybody)


vicky

Phil, did you get out of WFR in the 25/10kp? Jul 22, 12:23 PM


Phil

WFR - yes, stopped out! XXX Jul 22, 12:50 PM


Phil

SNDK/Tes - No mas for me, that was a terrible report and downside guidance. Still have hope for WFR but not much. Jul 22, 1:07 PM


jomama

Phil, what is your prediction on WFR’s earnings today. I know you are covered with the 55’s. They seem quite oversold to me. Jul 23, 3:23 PM

Phil

WFR - since they are big on selling to solars I think they will do great but SNDK was such a disaster they spooked me and the premiums are just too good to turn down anyway. Jul 23, 3:30 PM



Phil

Just passing by but WFR looks like massive overreaction to me, might be a nice buy in the morning. If my memory is correct, this puts their p/e down around 10, even with the lowered guidance, fantastic time to pick up 2010s at the money, maybe the $40s for $12 or the Jan $40s for maybe $7. This might even be our first new covered stock in stocks - I haven’t bought any all week, maybe sell the $40 puts…. Jul 23, 6:14 PM


Phil

WFR - waiting to see where it settles, probably will retest $40 before going up. Jul 24, 9:47 AM

Phil


WFR - selling current $45 puts for $4.25, 10 in stocks portfolio XXX Jul 24, 10:17 AM

troy

Phil - good call so far on WFR. I bought the ‘09 45’s today a little higher than you at $6.30. Good time to sell something against it or wait till it rebounds a little? Jul 24, 2:08 PM


Phil

WFR/Troy - it’s called long-term investing, involves waiting. I know it’s an alien concept to most here but sometimes it’s good to buy something and wait a bit…. Jul 24, 2:37 PM

The Jan $55s dropped from $9.80 to $3.60 and the $3 caller was wiped out. So our basis is $7.95 but we made it up on the puts we sold and the new positions we grabbed at the open and the LTP play is spit between the Jan $40s with a $13.95 basis (rolled down for $6) which are currently $9.95 and uncovered and the Jan $45s at $7.30, that were much cheaper to roll to at a $10.95 basis (+$3). Our plan is to sell Sept $50s for $3 or better (first 1/2, then more as it rises) to make up most of our loss by the end of July.


CROX, I think I said, was a wipeout we did not chase but was also from a portfolio that was shut down over the weekend so not an official positon of ours into earnings but I know you have to search very hard for something to attack me with so I don't want to deprive you...

Pre-earnings comments on CROX were:

Anonymous

any thoughts on CROX before earnings tomorrow? Jul 24, 11:28 AM


Phil

CROX - Not a clue! They got good news that their shoes are going into a medicare program and bad news that they get stuck in escalators and have injured some kids and the company will be adding tags to each shoe with a warning - not the kind of thing that gives moms the warm fuzzies and could delay shipments if they decided to hold it up for tagging (not to mention costs). Those would be Q3 issues but you don’t want them to guide down. Jul 24, 12:26 PM

mck

crox - I understand power of brand, but injection molded plastic shoes - aren’t they getting to be a commodoty? Every grocery store around here has them now for $5. Is there anything proprietary about a Crox pair? Jul 24, 1:19 PM


Phil

CROX/MCK - the material they use is special, some kind of breathable thing and very different when you wear it but, unfortunately, not when you look at it. Jul 24, 1:54 PM

[Oilwillpullback]

Phil- In fairness to BS, these are trades from just last week. There was nothing mentioned on the morning posts on any of the trades.

[Philip Davis]

I'm not sure I'm following that logic. We are a subscription service, we discuss 99% of our trades in member chat. The morning posts that are picked up by SA are simply a market overview that contain the occasional pick but we are a live site that buys, sells and adjusts positions all day long, 5 days a week. These free posts are a tiny slice of what we do... My evening wrap-ups are available to SA but they choose not to carry them but you can go to phistockwold.com and view them for free, including the weekend wrap-up, which details every postion we close each week - for free.

The trades mentioned above were all old, old trades and none of them were recent picks at all, they just happened to be 4 trades that ran into poor earnings so I'm letting BS know they were mentioned pleny in our chat and, after as well. When a trade is opened or closed in the $10KX, $25KP, Day Trading Portfolio, Butterfly Portfolio or Stocks Portfolio they are ALWAYS preceeded by a comment on the trade - no exceptions.

I could sit here all day and point out 100 trades that went fantastically but that's not what we do. I make picks publically and you can go back right here on SA and my own free site and look over 2 years worth of picks and decide if it's something you'd be interested in having more of. If so, then you join, if not, don't. There's nothing insidious about it.