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Stock Portfolio Profits
The Smart Profits Report: Issue #345
Thursday, August 14, 2006
Stock Portfolio Profits: Cashing In on Summertime Market Blues with Straddles and Put Options
By Steve McDonald
Advisory Panelist, Mt. Vernon Research
After melting my way through the brutal summer heat, it was certainly refreshing to pack up and head to Canada recently for a couple of investment conferences in Calgary and Toronto, where I was one of the featured speakers. With so many burning issues affecting the investment world these days, it’s no surprise that the turnout was strong.
And far from the doom-and-gloom pessimism that we see in the mainstream media every day, the climate was very much one of “what can I do to protect my stock portfolio profits?” Because despite what you’ve heard, there is a way to fight back against the many factors affecting investment portfolios this summer.
The Summertime Trio That Has Mauled the Market
It doesn’t really matter what the bad news happens to be: All markets hate the uncertainty that it brings. Take the events of the last few months, for example. What is traditionally the quietest period for the stock market quickly became a whirlwind that has left investors’ heads spinning and stock portfolios bathed in red.
- Oil: In the spring, oil prices approached $70 a barrel. The market promptly responded by heading south quickly. Just as quickly, the so-called experts in the media breathlessly ran their worst-case scenarios for $70 oil.
- Geopolitical Concerns: External factors are largely to blame for the uncertainty, with ongoing military battles in Iraq and Afghanistan showing little sign of improvement. Then Israel and Hezbollah added to the mess by engaging in full-blown war. Terrorism is also a persistent concern, with the recent plot to blow up flights from Britain to the U.S. serving as a chilling reminder.
- Inflation: Here in America, rising oil and energy costs ratcheted up the inflation debate, as the Federal Reserve kept tightening monetary policy to combat the situation.
In response to this potent cocktail, the markets have responded by delivering one of the most volatile periods in recent memory, with the heavy gyrations scaring investors into inactivity, or forcing them to the exits completely.
Let’s inject some reality back into the situation…
Bad News Always Gives Way to Stock Market Profits
Despite the market’s initial meltdown in response to $70 oil, oil prices are still hovering above that level. Yet the world hasn’t ended. The markets seem to have shaken the news off and are positive again.
Prior to the last Fed announcement, wild market swings seemed to indicate that the Dow was headed towards 10,500 and below. But the lowest point it reached this summer was around 10,650 and is now headed up again.
Even when Israel and Hezbollah started fighting, many thought this would crush the market again. But while stocks did drop, the ceasefire has smoothed the situation and the stock market has responded positively.
What can we conclude from this? Two things…
- First, no matter how bad the news, the stock markets are resilient and are extremely capable of absorbing every shake up and piece of bad news, and eventually shrugging it off and resuming business as usual. The overriding business of making money.
- Second, for you - the investor - the question is not so much how the markets will react to bad news, but how long it will take for them to neutralize it. More importantly, the lesson is to understand market history and behavior, and how you can use the bad climate to profit within your stock portfolio until that happens.
Here’s how…
Don’t Follow the Herd: Using Straddles and Put Options for a Sliding Market
How many times do you see investors allow their fear of market fluctuations drive their decision-making and flee at the first sign of bad news, often taking a big hit in the process? Don’t become the next victim of the stock market’s inevitable swings and set yourself up for a loss. The investment herd is never right and you’ll likely lose money by blindly following them out the door.
Here’s what you can do instead:
- Buy Put Options: Why wait for the market to start rising again before you can profit? Put options make you money when a security goes down. They’re a much cheaper and safer way of shorting a security, and it’s a great way to capitalize on the downside.
- Enter Straddle Plays: Given that no trend lasts forever, you can “straddle” your position and buy call options and put options at the same time. If the shares sink, your put option makes money for you and you can sell the call option. But if the stock quickly reverses and moves upward again, the opposite happens and you’ll make money from the calls and sell the puts. It’s an excellent hedge in a fluctuating market.
When the stock market moves down, just remember that its ability to absorb bad news is one of the few constants in investing. And you can still come out a winner if you know how to play it.
Good Trading,
Steve McDonald
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Today’s Smart Profits Cribsheet
- When you get caught in a down market, there’s no need to panic and rush to sell your positions or sit on the sidelines until the smoke clears. The key to handling this inevitable scenario is developing a “profitable downside bias” - something I wrote about in Smart Profits #311: Investor Sentiment and Market Behavior: Seven Tips for Developing a Profitable Downside Bias.”
- Need a refresher on what “put options” and “straddles” are? Check out the Smart Profits Glossary, it’s here to help!
Related Articles:
- What’s Happening in the Global Markets: The Global “Ripple’s” Headed Our Way
- Stock Market Volatility: Three Ways to Combat Volatility’s “Radical” Shift
- The Stock Market’s Reaction to Good News: Why It’s Best to Sell at the Sound of the Trumpets
