OT (sorta): The Elephant in the Room

I’ve been thinking about this post for several weeks, I’ve been reluctant to commit to writing because it may be volatile.

Let me start off by saying this is a strictly a question about investment strategy. I don’t care what your politics are and I don’t want to know. That being said, here goes . . .

I first voted in 1968. I’ve been politically engaged ever since. That makes me a pretty old guy. I have never witnessed anything like what’s going on in the political arena as what is going on right now. My experience as an investor is far less. Yes, I dabbled in the market during the dotcom bust, but I had little to lose at the time. In 2008, the damage was more serious, but not devastating.

From what I’ve read on this board, many folks here seem to think the market is largely disengaged from politics. That may be true to some extent, but I’m of the opinion that an extreme political event will negatively impact the market. It really doesn’t matter much what the event is, I won’t speculate and I’m not asking anyone else to do so. All I am suggesting is that such an event is highly likely.

My question is this: In the event of a sudden and severe market downturn, I don’t want to just insulate myself from large losses (although that would be a minimal requirement). I want to profit from it. We all know that there are ways of generating returns no matter which way the market goes, but I am woefully short on strategies that can be put in place in advance in that no one knows when such an event may take place. However, I think it’s inevitable.

GTC stop-loss orders are not a good strategy for a number of reasons. At best they may limit one’s losses to some extent, but there’s no way to profit from them. They are also very cheap as they don’t cost anything unless they execute.

Buying puts doesn’t seem worthwhile either. Puts on what? Options are wasting assets, I think not well suited to a what if hedge for and event that might occur who knows when. Seems like one could spend a lot of money buying puts that never materialize in a gain.

So far, the best thing I can come up with is shorting the S&P or some other index. Probably not too expensive and it doesn’t have an expiration date. I’ve not really looked into this.

Some of you that have been actively engaged in investing a lot longer than I must have some strategies to deal with this. Saul, what did you learn from 2008? What would you do differently the next time around? How will you make this work to your advantage when the next meltdown comes?

A lot of folks who are regulars on this board have a lot more experience than I, I would like to hear from you on this topic.

Thanks in advance - And remember, no political discussions, please keep it to investment strategies.

19 Likes

One word… Bitcoin

… OK… maybe gold… or real estate.

RGB

I work in financial sales, and one of my clients I met with in December was looking to get away from stocks and the market completely because he is burned out. The reason? He has been shorting the S&P500 for more than a year. Every month he has to pay margin calls and they are absolutely killing him. The guy had around $300k when he started, now he is down to less than $90k.

He’s a brilliant guy too, works as a researcher at the CDC.

I don’t have any real answers for you as far as how to profit when the inevitable downturn comes, just a word of caution for the idea of shorting the S&P.

I tend to lean on Saul’s often repeated reminder that there is no point in trying to time the market. Just invest in companies you understand and believe in, that have certain financial markers. The timing will work itself out over the long term.

There is only one way to happiness and that is to cease worrying about things which are beyond the power of our will. - Epictetus

20 Likes

My question is this: In the event of a sudden and severe market downturn, I don’t want to just insulate myself from large losses (although that would be a minimal requirement). I want to profit from it. We all know that there are ways of generating returns no matter which way the market goes, but I am woefully short on strategies that can be put in place in advance in that no one knows when such an event may take place. However, I think it’s inevitable.

GTC stop-loss orders are not a good strategy for a number of reasons. At best they may limit one’s losses to some extent, but there’s no way to profit from them. They are also very cheap as they don’t cost anything unless they execute.

Buying puts doesn’t seem worthwhile either. Puts on what? Options are wasting assets, I think not well suited to a what if hedge for and event that might occur who knows when. Seems like one could spend a lot of money buying puts that never materialize in a gain.

Volatility is VERY low right now, indicating high optimism. Several talking heads are saying the crowded trade is shorting Vol (crowded trades become dangerous. If you were to shot vol, that essentially means selling a put (putting you at risk), but what is now a low price. You can protect yourself buy doing the opposite, buying puts. Yes they are a wasting assetm, but can you short the S&P and stand it if it melts up 10% from here. How could the S&P keep going up? Well, earnings are beating expectations at a high rate, indicating “it” is not all built into the market. Interest rates are going up, which means bonds are going down. If you are a bond holder getting 2% a year and your bonds go down 2% in a week, and the market goes up 7% the first 3 weeks of Jan, you might start moving your money to the market. Also, after a big year like 2017, the propensity is for another good year, 8-10% (but we are up 7%).

Stop loss orders are super deadly in the world of flash crashes you can get stopped out of all your stocks in the morning at 15% loss, only to see them all come back at the end of the day (without you). Instead, set alerts for x% changes in prices and drops below certain prices. Then act if you want.

ok, so how to really protect…BUY PUTS. You don’t want to, but they are cheap. Only buy to protect yourself from a huge drop, not 5%, but maybe 15%. We are do 10% easy and that takes us 3% where we started on Jan 1. So, you can buy an out of the money put 3-6 months out for a small price, say 1% of your portfolio. If the market does not fall much, you lose that 1%, but big deal. If the market drops a lots, you can greatly cushion the blow.

A “costless” play is to buy one put out of the money and then sell two lower priced puts that add up to the same cost. That is a net of about Zero, If the market falls between you puts and the ones you sold, you keep all the gains while your risk expires. If you call below the price of the one you sold, then 1 of the ones you sold cancels the one you bought and you will have to take posession of the S&P (SPY) at what might be a great price on the dip (assuming you have cash).

Don’t buy the VIX, that is for very short term only.

If you are really worried, start cashing out part of you shares of stocks that have made good runs and just decide how much cash you need to sleep at night.

P.

13 Likes

Saul had a very good post to this question and has mentioned several times not to panic . If you believe in a Company and nothing has changed, they eventually come roaring back, but have some dry powder available to pick up these Companies on the cheap…
Example… Shop…today back to where it was after the Citron attack…over three months ago.

No doubt Saul will tell it better.

2 Likes

Rock, I’m at a loss here.

We’ve been through Viet Nam when the country seemed on the verge of tearing apart.
We’ve been through the cold war when grade schoolers practiced hiding under the desks. (That’ll save 'em from the nukes.)
We’ve had a President assassinated.
We’ve had a President resign in disgrace.
We’ve had a President proven to lie to Congress during hearings.
We’ve had the OPEC crisis and were convinced there was little gas left on planet Earth.
We’ve had a financial crisis so severe that the biggest banks in the world couldn’t begin to handle it themselves.
We’ve had a market where any company ending in dot.com was worth many times any ‘normal’ valuation.
We’ve had (have) major wars with thousands of our soldiers dying and horribly wounded.
We’ve had volcanoes, earthquakes and the biggest hurricane ever to hit the continent in recorded history.
We’ve had government shutdowns.
We’ve had 19% interest rates.
We’ve had 0% interest rates.
We’ve had housing booms galore.
We’ve had housing busts galore.
We’ve had the Savings & Loan crisis.
We’ve had too many banking crises to remember.
We’ve had fraud at Enron that threatened all markets.
We’ve had hackers getting into banks, credit card companies, credit gatherers, huge companies of all kinds.
We’ve had high inflation.
We’ve had deflation.
We’ve had politicos impeached, indicted, convicted and forced to retire.
We’ve had CEO’s impeached, indicted, convicted and forced to retire.

Are you sure we haven’t seen this before? What am I missing?
You may be right, I can’t stand to follow politics any more. But I honestly don’t know what you’re referring to.

One of my core beliefs has never let me down. I hope it continues. …and this too shall pass.

Otherwise …

I have made money shorting sectors with ETF’s, but any time I’ve tried to short anything larger, the
market invariably did what I thought was the most unlikely thing to happen. But If you think you know
what is going to happen, analyze what parts of the market will suffer most and have your ETF or whatever
vehicle you are going to use, ready to go. If you’re really sure, there are 2x and 3x ETFs to short
all major flavors. Make really sure you’re really sure. :slight_smile:

(and call me first?)

Dan

47 Likes

<<<What would you do differently the next time around? How will you make this work to your advantage when the next meltdown comes?>>>

We would have to go back in time on NPI. Seems to me that most of us on that board anyways, kept holding out good quality stuff and then bought more. I know a few years it we were all (well, at least I assume so) sitting very nicely after having road it out, and just bought more.

A lesson learned is when you really find a singular company, with enormous CAP, just by the dang thing.

We quibbled on NPI about ISRG. We said if it hits $90 I’m buying! It hit something like $95. What is it today…yeah, yeah, four figures.

You do realize that the second largest increase of stock market in presidential history was during the Great Depression. In fact, if you bought quality companies, by which I mean the singular companies like RCA was back then or Ford or what not, by the time the Great Depression was over you had made quite the score. Some of the best years in the market (And the worst, almost every other) was during the Great Depression.

You know, when 9/11 hit in 2001, I woke up at noon. Thought nothing of th day, and then I saw this video of airliners crashing into the WTC. At that point I went, well, there goes my portfolio to ash, and I figured we had a lot bigger things to worry about. And so we did.

Ignoring the human tragedy and geo-political issues, to stay in point. What would you do after 9/11…umm, BUY STOCK IN QUALITY COMPANIES, HOLD ON TO STOCK IN QUALITY CONPANIES.

My definition for quality companies are those that are “singular” companies, with high CAP, and long runway of growth, with no disruptive innovatiaons make them obsolete (like what happened with AOL as an example with Broadband).

Lesson learned many times over. I won’t forget it. It may hurt for awhile. But I will not forget it the next time such things occur.

Tinker

5 Likes

What’s CAP?

John

Buying puts doesn’t seem worthwhile either. Puts on what? Options are wasting assets, I think not well suited to a what if hedge for and event that might occur who knows when. Seems like one could spend a lot of money buying puts that never materialize in a gain.

That’s the wrong way to look at buying puts. Puts are insurance. When you buy fire insurance you hope like hell it never pays out. Same with the puts. They work much better than shorting (very risky) and better than stop loss orders (moderately risky).

My experience is that quality companies bounce back and while iffy ones go broke. Don’t hold iffy stuff except for speculation. One of the biggest dangers of crashes is debt. If you don’t have debt it is very difficult to go broke. If you do have debt and it is called in by the creditor, you have a huge problem and the same applies to the companies you are invested in. I stay clear of companies with high debt and companies with credit risk. Most financial institutions have credit risk, not so MA, VISA, and TREE.

In summary, if you have a sturdy portfolio you have all the protection you can reasonably expect to have. You might buy puts for extreme crashes. Should the stock drop below the strike price you have two alternatives: collect the option’s intrinsic value* and keep the stock or sell the stock for cash.

Polonius

“Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.”

https://literarydevices.net/neither-a-borrower-nor-a-lender-…

Debt is the gravest risk.

Denny Schlesinger

  • If the strike price is $50 while the stock’s price falls to $40 the intrinsic value of the put option is $10.00. Selling the put you have a realized gain on the put and possibly an unrealized loss on the stock depending on the price you bought it at. Selling the stock has a similar effect as a stop loss order. With the stock above $50 the option expires worthless.
3 Likes

First,

It has been my experience that investing based on macro economics will make you poor.

Second,

The belief that politics has little to do with market is based on history. Pull up the Dow Jones industrial average from
1920 to present.

Look closely at 1939. Invasion of Poland, Dunkirk.

Winter 1941-1942 Pearl Harbor.

1963, assassination President Kennedy.

1973, resignation of Nixon

March 1981. Day Reagan was shot.

9-11

Except for Nixon and 9-11 the market barely moved. In the case of Nixon we already had significant market issues - energy, monetary policy.

With 9-11 it was a bit different. As much as I love to deride the “Banksters” on Wall Street, when the towers fell a lot of planned economic activity that the people working thier were in the process of starting died.

The fact is: We always live in scary times. Worse, they will probably get worse.

On the other hand, the world is creating excess wealth at a rate never before seen - ever.

If you would like a fresher view. Go and watch every video made my the late Hans Rosling. He was a genuis at extracting the truth from data and communicating it well.

Cheers
Qazulight

21 Likes

If you would like a fresher view. Go and watch every video made my the late Hans Rosling. He was a genuis at extracting the truth from data and communicating it well.

I saw a couple of his presentations, marvelous! The one fact that stands out head and shoulders above all others was the effect of the Dutch and British East India companies on the acceleration of world wide economic growth during the 17th century. These enterprises were made possible by the joint-stock company laws. Simply put, some enterprises are so huge that only a collective is capable of financing them.

Early joint-stock companies

In more recent history, the earliest joint-stock company recognized in England was the Company of Merchant Adventurers to New Lands, chartered in 1553 with 250 shareholders. Muscovy Company, which had a monopoly on trade between Moscow and London, was chartered soon after in 1555. The much more famous, wealthy and powerful English (later British) East India Company was granted an English Royal Charter by Elizabeth I on December 31, 1600, with the intention of favouring trade privileges in India. The Royal Charter effectively gave the newly created Honourable East India Company a 15-year monopoly on all trade in the East Indies.[10] The Company transformed from a commercial trading venture to one that ruled India and exploited its resources, as it acquired auxiliary governmental and military functions, until its dissolution.

Soon afterwards, in 1602, the Dutch East India Company issued shares that were made tradable on the Amsterdam Stock Exchange. That invention enhanced the ability of joint-stock companies to attract capital from investors, as they could now easily dispose their shares. In 1612, it became the first ‘corporation’ in intercontinental trade with ‘locked in’ capital and limited liability.

https://en.wikipedia.org/wiki/Joint-stock_company#Early_join…

416 years later we are reaping the rewards of the “Stock Exchange” but more important is the proof that you need great accumulation of wealth to kick the economy into high gear. The repercussions are political so I’ll stop here.

But do follow Qazulight’s recommendation and seek out Hans Rosling presentations.

Denny Schlesinger

4 Likes

Replying to myself rather than each person individually . . .

Thank you all for the input. I appreciate the serious responses and mostly apolitical or at least non-partisan replies.

In a nutshell what I think I got from this is that strategic use of put options is probably the best strategy to protect against a sudden downdraft. While I think this event is inevitable, I don’t think it’s imminent. Of course I don’t know when. I guess I’ll bone up on option strategies which is not an appropriate discussion for this board.

I’ll also look into the Hans Rosling presentations which I gather provide more perspective than strategy.

1 Like

In the event of a sudden and severe market downturn, I don’t want to just insulate myself from large losses (although that would be a minimal requirement). I want to profit from it. We all know that there are ways of generating returns no matter which way the market goes, but I am woefully short on strategies that can be put in place in advance in that no one knows when such an event may take place. However, I think it’s inevitable.

I like the idea of assembling a globally diversified mix of assets that include healthy doses of classes that are not highly correlated with one another. Minimize your costs, and if you want to account for market valuation or other economic factor, then implement some strategic increase/decrease of cash and other asset weighting to reflect your judgement, but maintain investment across different classes because it’s easy to be wrong on just when the party stops or starts.

A portfolio including global total market stock and bond funds is a great core. Add allocations to cash, real estate, commodities. Rebalance once or twice a year, which will have you selling high and buying low and ensure long-term profit.

3 Likes

This article discusses multi-year S&P 500 losing streaks: https://novelinvestor.com/sp-500-multiple-losing-years/ . (through mid 2015).

• Consecutive losing years don’t happen often – only four times for the S&P 500: ’29 – ’32, ’39 – ’41, ’73 – ’74, and ’00 – ’02
• While two, three, or even four consecutive losses don’t guarantee a positive return will follow, each of the four periods eventually ended with a 20+% return.
• I ran 5 year returns following losing years. The four losing periods were all followed by above average annual five year returns ranging from 12.8% – 17.9%. Investors able to stick with it or invest into losing years were rewarded.
• Positive “following year’s returns” didn’t come close to making an investor whole, assuming they ate the total losses and didn’t sell. But missing those returns put a big crimp in getting back to even.

2 Likes

I’ve been using options to buy protective collars on some of my biggest long-term winners, to be sure I capture at least current gains. (Sell the call, buy the put, net cost zero). If I’m honest, these may also be many of the companies I’m looking at the closest to sell completely as I learn about and negotiate with myself for a more concentrated portfolio.

I’m holding ~55 equity positions after years in a variety of Fool recommendations, plus positions from other sources. For the most part the winners have been spectacular, the losers, well just losers. Some for far too long. I’m trying to build a bigger cash position, which I know isn’t the point of a concentrated portfolio. Like I said, still learning and negotiating with my risk tolerance.

1 Like

There was a pretty good thread on option hedges for those inclined here:

http://discussion.fool.com/1081/hedges-32625456.aspx?sort=whole#…

We can discuss more over there since this is option related.

I really like the “risk twist”.

Sell one SPX/SPY put at 40 delta
Buy three puts at 20-24 delta
Sell one at 18 delta.

Do this 120 days to expiry… You have to close this 30 days out!

This trade has several features:

  • tail risk, protects a large drop
  • doesn’t protect a small drop
  • if you don’t close in last 30 days, you will lose time value quickly, have to remember
  • minimal drag if market goes up.
  • when market goes down, volatility goes up. This trade goes up strongly in volatility up environment (vega positive).

Each month I have been closing the one 30 days out and buying a new one. This makes me feel a lot better about a large general market drop.

Gator

1 Like