Fear Is Irrelevant

 |  Includes: DIA, QQQ, SPY
by: Tycoon Report

We just experienced the third worst performing September since 1950 with the S&P 500 losing 8.6%. If that makes you sick, then I won't tell you that the NASDAQ Composite posted a loss of 11.64%. Oops.

The Dow was down a whopping 800 points (-7.7%) intraday yesterday before closing down "only" 3.58%. The S&P fell 8.16% intraday, ending the day down 3.85% while the NASDAQ Composite plunged 9.61% intraday, recovering to close down 4.34%. So is this dismal September giving way to another Black October?

I know, I know, it's scary. But the way you should view this is just the same way you might have thought about a bull market when the market rallied to a new high. 

What do I mean? 

You may have missed out on some big profits back when the market was at a peak in a long-term UPTREND, but instead of thinking about the world coming to an end, you were probably thinking about the next stock market pullback and what you'd buy when that inevitably happened. It's easier to think clearly about buying on a dip in a major uptrend because you don't have FEAR clouding your judgment. But that same exact concept applies to today's market.

You WILL have another chance to profit from a big downside move. (Hopefully you took my advice and made some profits on bearish plays this time around.) But instead of thinking about the money you are losing on your bullish positions, you should try to focus your game one or two steps ahead of the stock market.

First of all, according to the Stock Trader's Almanac, the absolute worst September since 1950 (for the S&P 500) was in 1974, which posted a loss of 11.93%. However, the following month posted a 16.3% gain - the single biggest October gain since 1950.  The second worst performing September was in 2002 when the S&P 500 posted a monthly loss of 11%. But once again, October reversed most of those losses, posting a gain of 8.64%.

So while this market is ugly, and the economy is certainly ugly, I want to tell you three important things:

1. Be sure to separate your "economy time line" and your "stock market time line." They are two very different things. By the time it's announced that we are/were officially in a recession, the market will probably be well off of its lows, if history is any judge.  The stock market leads the economy, so don't make the mistake of aligning the two time lines.  Even the most seasoned stock market veterans make that mistake.

2. Cheer up. I know you probably have bullish positions that are all beat up right now. Join the club. But take solace in the fact that while we just finished living through the third worst September since 1950 (red arrow), the first and second worst Septembers were darn close to bear market bottoms. The 2002 - 2003 bottom saw its second bottom in early October as you can see below (blue arrow). 

Here's a 10-year chart of S&P 500. 

Let's take a closer look at the October 2002 bottom (second bottom out of 3).
Again, this was followed by an 8.64% gain in October.  Now check out the 1974 bear market bottom (blue arrow).

S&P 500 Jan 1973 - Oct 1975

Once again, this was followed by the largest October gain since 1950, which was 16.3%. Let's zoom in once again to this 1974 low.


I am certainly not calling a bottom, and I'm not telling you to run out and buy stocks yet. I don't try to call bottoms. Waiting until a bottom is confirmed gives me a higher reward/risk ratio, and this is certainly no confirmation of a bottom.

I am making a point here that the media will scare the living daylights out of you in any way possible - for ratings. You are probably hearing or reading about how ugly September was, and that we are in for another Black October.

The economy has a lot more to deal with. If you are shivering in your boots, you may consider "lightening up" by selling partial positions and taking some bearish positions on the next rally. But what you want to do now is focus on the next steps, which brings me to...

3. There is almost ALWAYS a second or third bottom made at or near the same level as the first. So you'll have another chance to profit from the strong downtrend. You can see in the charts above what I'm talking about - especially in the 2002-2003 stock market bottom. But the reason this is so incredibly awesome for people who trade put options is that your gain comes from two places: direction and fear (implied volatility). 

For example:

XYZ stock may be trading today at $32.00/share. 

The March 40 put option may be trading today at $9.00 if we were in a market that was happy, comfortable, and moving higher. 

But that same exact put option might be trading at $11.00, even when XYZ stock is still trading at the same price of $32.00, if the market is extremely fearful. That's because people are willing to pay more for put options in that case. Said differently, the option would be trading at a higher price because it has more "implied volatility" in the price.

My point is, if you buy put options on the next big rally, when everyone is feeling a bit more comfortable, you will be buying them when they are relatively cheap. When the market turns back around to "re-test the recent low" the put options (if the underlying stock is going down) will go up for two reasons:

  1. Because the stock is going down, and puts have an inverse relationship to the underlying stock.
  2. Because FEAR is coming back into the market causing the put options to become even MORE expensive.

If the stock traded from $32.00 down to $27.00 in a bull market or a flat market, the put option might trade from $9.00 up to $13.50.

But if the stock traded from $32.00 down to $27.00 in this bear market, the same put option might trade from $9.00 up to $16.00.

Stay tuned, folks. In times like these, I find that many people want to avoid looking at an ugly market, but still want to know the scoop.