Governing ourselves..Tom Dorsey.
What does "govern ourselves accordingly" mean. It can mean many things to many people.
What is right for one person may not be right for another. There are many right answers. If you are unaware that the indicators are in high risk territory you might just continue to buy stocks with unbridled enthusiasm.
For most of us though, that would not be the tact we would take. Here are some ideas that might make sense.
Do nothing. Tighten up stop loss points. As stocks start to give sell signals you ensure that you don't give back too much of your profits. You might choose to just take partial positions off the table on the sell signal but by doing that you have taken some defensive action.
Take partial profits. One thing you might consider is selling a third of your position if you are up 30% or more. This gives you staying power with the rest of your position to handle a correction.
The money you free acts a hedge and then you have that cash to re employ once the indicators suggest you have a good buying opportunity again. As well, taking partial profits will keep one stock from becoming to large a portion of your portfolio.
Sell calls against partial or total positions. This takes the sell decision away from you. You take in premium which acts as a hedge against you and you sell at the strike price. If the stock doesn't get called away, you keep the premium and can re-write the calls. Of course with this strategy you must be willing to have the stock called away. If you are not willing to have the stock called away, then you're a closet naked writer.
Buy protective puts on particular stocks. Let's say you own MBIA Inc. (MBI). The stock is at the top of its ten week trading band, the weekly momentum just flipped negative, and the sector is extended and the next support is the 64 area with the stock currently trading around $76. You might be willing to accept the risk down to 70 but after that you wants someone else to carry the risk. You might choose to buy a six month out put struck at 70. That gives you the right but not the obligation to sell the stock at $70 anytime between now and expiration no matter where MBI is trading. If the stock does in fact fall, you can always take the profits on the put and hold the stock.
Buy protective puts on a portfolio. Ask anyone if they own a put and most would say no. Ask anyone if they own a home or a car and you get a resounding yes. If you own a home or a car you own a put. You own insurance on your home and car. Every six months you send the insurance company a check to protect you for the next six months should there be an accident. Many people have portfolios worth more than homes and yet they don't even think to buy insurance on their stocks should there be an accident in the market.
Let's say you have a portfolio worth $200,000 of blue chip names. You know you can handle a 5% drop in the market but after that you want some insurance.
The OEX is current trading at 525. A 5% drop in that index would bring it down to 500. One way to hedge the portfolio is to buy puts on the OEX struck at 500. For each put that you buy it protects $50,000 (500 X 100) of the portfolio. To hedge a $200,000 portfolio you would buy 4 puts. The price you pay for the puts is like the car insurance premium you pay every six months to your insurance company.
You hope you don't have to use it but if you do, you're sure glad you have it.
Also, you don't have to buy protective puts on the whole portfolio. You can hedge just a partial portfolio.
Buy only half positions here and average in the other half on a pullback. This allows you to at least get your foot in the stirrup in case we don't get a pullback. If the stock does pull back then you can average in lower.
Buy calls or leaps on stocks you want to own. Let the premium you pay be your stop loss point and come back at expiration and see how you stand.
The important thing to remember here is not to overleverage. If you normally buy 500 shares only buy 5 calls; don't overleverage by buying 15.
Keep the rest of the money in a money-market fund.
Tom D. |
