Bernie Schaeffer's April Option Advisor Commentary: Facing Up to the Risk of a Decline
By Bernie Schaeffer
3/25/2002 11:33 AM ET
The following is a reprint of Bernie Schaeffer's market commentary from the April edition of the Option Advisor, published on March 21. Prices are as of the close on March 21. For more information or to subscribe to the Option Advisor, click here.
"The only way anyone can make a profit in the stock market is by doing the opposite of what someone else wants to do whose judgement is not so good … The public pays (the insiders) their profits … It was only after the public had been reassured by this strong recovery and had begun to buy back (at higher prices) the stocks it had dumped overboard in panic that the insiders again turned safely to the selling side." Richard Schabaker, Stock Market Profit, 1934
"New money going into stock mutual funds is projected to exceed $60 billion during the first quarter (of 2002), the highest total for a three-month period since the second quarter of 2000, according to estimates by Strategic Insight … By comparison, $114 billion was added in the first quarter of 2000, prior to the top." The Wall Street Journal, 3/21/02
"If you're in a poker game and you don't know who the patsy is, then you're the patsy." Warren Buffett
The patsies are out in full force, and as usual Wall Street is enflaming their passions. As James Grant has so correctly observed, this is a "bear market that thinks it's a bull market." CEOs still shamelessly huckster their stocks on financial TV and the public still pounces on every hint from tech companies that can best be described as "the living dead" that a "recovery" may possibly, hopefully be around the corner. And the Dow Jones Industrial Average (INDU – 10,480), the world's most manipulated index, has just staged a screaming and headline-inducing rally toward the top of its perpetual trading range. In other words, the sheep have dutifully lined up for their fleecing.
But hopefully you will not be among them. In fact, it's my intention that you survive and perhaps even prosper over the course of what I see as a very rocky market road ahead. If you've been reading my various newsletter and Web commentaries for the past 18 months, you are well aware of my ongoing belief that the combination of questionable fundamentals, weak technicals, and "over the top" hopeful sentiment renders minuscule the probability of a sustained stock market recovery.
This is not to say that I haven't given the rally off the September 21 bottom (which I admit came as a surprise to me) a rather wide berth as a counter-trend force with which we must reckon. And this is not to say that this rally is going to end tomorrow or even next month. But I strongly believe that the time has come to take some serious measures to anticipate a major market decline before 2002 is over, if not an all-out market crash.
Ironically, at no time since mid-2000 has the cost of purchasing put options to protect your portfolio or to speculate on a market decline been as cheap as it is as of today's market close! Why? Certainly not because there is a lack of things to fear. In fact, such a list would be way too long and too distracting for this space. No, the reason that puts are so cheap is that there is a near-mania in the almost universal belief that "the worst is over" and that a stock market bottom is firmly in place.
"So, Schaeffer," you might ask, "what's wrong with that?" Nothing, unless you care about preserving your capital, because the world in which we live has had from time immemorial a strange way of rewarding such complacency. It's called the kick to the groin followed by the uppercut to the jaw. In fact, we don't have to go back further than the summer of 2001 to note a period of similar complacency, and that was not a good time to own stocks.
"But," you may say, "surely you aren't counting on a repeat of 9/11 as the basis for your concern." No, I'm not. All I'm counting on is the very strong possibility that the rosiest of all possible scenarios that is currently dominating the thinking in the investment world will not come to pass.
As Nassim Taleb states in his recent book, "Fooled by Randomness" (underlining mine): "A seller of out-of-the-money options is betting that an event will not happen; a buyer of these options is merely betting that it may happen … It is not how likely an event is to happen that matters, it is how much is made when it happens that should be the consideration." The bottom line is that there are a whole bunch of less-than-perfect scenarios that could derail this market rally. And there are another bunch of horrible scenarios that could lead to a genuine market crash. The risk is there and it's real. And the price for protecting against these negative outcomes is too cheap to pass up.
Based on Bernie's market outlook as set forth above, he recommended that his Option Advisor subscribers allocate a higher percentage of their account to a specific longer-term option play designed to take advantage of cheaper option prices. Because this trade was based on Bernie's overall market view and his assessment of current option pricing, this recommendation had a higher target profit than the typical Option Advisor pick. For more information on how you can take advantage of Bernie's exclusive insight and option recommendations, click here. |
