Going With The Odds

Based on a previous article by Paul at Real Money Pro, published on February 4, 2014. 

Paul Price took advantage of the market selloff to SELL more puts. Our Virtual Put Selling Portfolio is based on taking bullish positions by selling puts. (See details here.)

Too bad Paul's electricity/internet was out on Wednesday and Thursday or he might have been more active. (He appears to be unconnected and cold again.) 

The following is adapted by me from Paul’s daily article at Real Money Pro originally published on Feb. 4, 2014. 

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Recent negative market action marked the twelfth time since the March 9, 2009, that the broad market pulled back over 5%. Those scary drawdowns were mostly in the range of 5% to 7%. 

Several of the selloffs were steeper. The August 2010 debt-ceiling drama plunged indices about 16% lower. The Greek tragedy/European banking crisis of 2011 precipitated a 19.4% decline. (Base chart via Doug Short, inset by Paul.)

 

During these periods of decline, buyers stop buying at the higher prices, bids drop and prices move lower. Nobody wants to own stocks while they are falling. It’s better to buy AT the lows and sell AFTER prices recover. Unfortunately, timing the turning point is almost impossible. 

What we do know is that the previous eleven significant selloffs ended up leading to record highs on the S&P and the DJIA. Does this mean the current one will? No. However, selloffs have been buying opportunities since the 2009 lows and we have no good reason to believe this one is different. 

During Monday’s rout, the volatility index or VIX, i.e., the ‘fear gauge,’ reached relatively high levels. Monday’s VIX almost hit the highs registered in late 2012, mid-2013 and October 2013. During those periods, stocks should have been bought, not sold. 

Look at the chart below. The base chart is by Doug Short. The inset is Bespoke investment. And the lines showing the correlation between market selloffs and VIX peaks are by Paul. 

 

Of course a 5-6% decline may not be the end.  Stocks can fall further. But if your goal is to buy stocks at attractive prices, don’t let the fantasy of guessing the bottom keep you out of the market. Market timers are notoriously wrong. If  you evaluate individual stocks on their merits, you won’t get caught ‘frozen in the headlights’ while falling indexes present opportunities. 

I’ve been selling puts with 6-month to 2-year expiration dates. This allows me to to essentially place below-market limit orders without trying to call the bottom. If I end up owning the stock, it will be at a lower price. 

I’m betting that the twelfth greater than 5% selloff will end the same way as the last eleven--in higher prices. 

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