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Trading Defensively In This Market


Very effective Options strategy.

trade defensively earning passive income.

strategy offering Protection for downside moves.

This article is about te strategy I’m using new to make money in this market. I’ll first give a brief summary to the market situation today, and then layout the strategy I m using to make money while controlling risk in this market.

The market today has reached record-level highs making me a bit nervous. While objective metrics like P/E are not at record-level highs, they are a bit rich. The risk of a market recession is objectively high. Not only do I feel that markets are getting too euphoric, pricing some star stocks at multiples rarely seen before, but macro views are not that good too. Indeed too many tensions are present : interest rates increase, tensions with europe, canada, korea…

While the market could still go up and overheat in the next 2 years, it could crash badly too on any escalation of these tensions .These facts should make any investor nervous.

Being pretty familiar with options trading, I decided 2 years ago to try this strategy which combines market neutral, passive income, defensive stock investing ideas. And I have to say that the results were quiet good.

The main idea behind this strategy is basically to use the idea most successful hedge funds use, which is identifying objectively cheap stocks using PEG, P/B metric, debt levels , ROE… but with a twist.

Indeed, instead of just buying outright these stocks, I decided to add another criteria which is high implied volatility (more than 25%). And then buying an SPY 2 month at the money options and shorting 1 month at the money options of the stocks meeting my criteria making sure that the delta of my portfolio is neutral.

To illustrate the resulting portfolio with numbers, let’s assume our initial capital is 10 000 usd, and we are willing to use 50% leverage. Let’s assume the average implied volatility of our stock is 28%. This results in a theoretical yearly passive income of 1 500 usd.

The beauty of this strategy is that while the returns are pretty good, our choice of diversified and defensive stocks make us well protected and even being able to profit and earn more money in the case of a huge market drop.

In the next week, I will give more details on how I choose my stocks and how my portfolio fared with this strategy so far.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.