A Return of Market Volatility
Throughout the course of 2013, the markets have seen a meteoric rise. Most major markets have experienced 12% or more gains in the first five months of the year. This type of return would be considered a fantastic one year performance. 2013 is not your typical year.
As we approached the end of May, we begin to hear so-called market experts call for a down turn. They have said the Fed will discontinue QE regime, and that the market have been artificially held up by the excess cash reserves flowing into the equity markets. A correction is typical of a bullish equity market but this correction shouldn’t signal a reversal in the overall upward trend.
The important lesson to take from this is to be prepared. We purchase insurance because we cannot predict the future. This type of strategy can translate to the equity markets also. I will lay out some simple strategies that will help the investor hedge against a down turn in the market.
1. Inverse ETFs Exchange traded funds allow us to diversify our portfolios with one position. If we are anticipating a pull back or bearish trend in a market or sector, we can invest in Inverse ETFs. These positions will gain value as the market or sector is declining. The S&P 500 has a few options for an investor to choose from: SH (1:1 leveraged), SDS (2:1), SPXU (3:1).
2. Covered Calls This is an option strategy which you hold the shares and elect to sell them at a desired price (strike). When a call contract is sold, you are also generating cash flow (premium). If the market is moving down and does not reach the strike by expiration, you keep the shares and the premium. This is a conservative way to generate cash flow on stock positions in a declining market. If the strike price is reached, you will sell the shares at your desired price and keep the premium.
3. Put Position A Put is another option strategy. If an investor owns shares and wishes to protect gains but has become bearish, buying a Put Position on the underlying stock will help. If the market goes negative and the strike price is reached before expiration, the stock will be sold at the desired strike price regardless of how far the stock price falls.
4. Beta Beta won’t allow the investor to take profits or protect against a downswings but it will give awareness as to how correlated or volatile a particular stock or portfolio is in relation to the market. A Beta of One means a stock/portfolio will almost exactly mimic its’ index. The further below One indicates lessor volatility versus the index while above One is associated with added volatility. A zero Beta is typically associated with cash positions. If a stock has a Beta of 0.50, this stock is measured as having half the volatility as the index.
Although these are basic concepts to incorporate, timing and entry levels are often very challenging and difficult to decipher. Overall market awareness is critical when developing an investment strategy. A trusted Investment Advisor should be able to offer this insight to protect the clients’ assets. I can be available for consultation of these and other strategies when appropriate.
