I give up… the markets are crazy. What should I do now?

It is not only the market traders who share the anguish caused by the market turmoil.  one friend writes:

“I think I should write an article too but from the standpoint of the wife of a hedge fund manager. I never thought that I would spend more time focusing on the “market” than anything else around us. I wake up with CNBC, I go to sleep with CNBC. Our life-style, our kids’ future, our home, vacations, my sanity! depend on “the market”, this absurd, violent ‘thing…’

Most investors and traders have taken a beating this year.  As the market whipsaws to investors’ need for  liquidity, or to run for the hills, or day-trading, or, yes, to double down, there have been few winners.

With a hint of fear and trembling in their voice, I have been asked many times over the last few months about what to do next in the market.  It usually goes something like this:  “my [wife] [husband] [f buddy] [domestic partner] [girlfriend] [boyfriend] [lover] [friend with benefits], one of the scared-y cats, is very nervous about the markets… a friend suggested selling everything, take the loss, and re-buy other assets (after the 31-day limit) or buy a call option to avoid missing any bounce-back… what do you think??”

Hm.

Well first of all, there is no absolute answer, because ten people in a room could all have a different path based upon their own capital needs, near-term and far.  But there are some things you should not do.

I am not a fan of free investment advice, so please take my own advice with healthy skepticism.  There are  many voices on the cable shows devoted to financial info-tainment, but, despite their loud blather, they do not add up to much more than a whisper of usefulness.  You and only you have a full understanding of your risk tolerance and your objectives.  Nonetheless, irrespective of your detailed objectives, your probable intent is to earn returns and to stop losing money… so there are a couple things you can do on general principle.

If you need liquidity now, then there really is no dilemma.  Sell.  If you need cash now, the only thing better than cash is money.

If, however, you own a truly diversified portfolio of investment assets, then those assets probably do not represent “I need it now” money…. in that case, I would advise against it.  Don’t sell yet.  There are better alternatives.

Volatility premiums in the options market are very high.  If you are willing to pay a premium in 31 days, after a liquidation event, then do not wait.  You can construct a synthetic call option or put option based upon the current constituents in your portfolio.  A call option can be constructed synthetically by being long the cash (stock) and buying (long) a put option.  You can buy put options individually for each of the long stock positions in your portfolio or you can simply buy a put option on the broad index such as SPY… Look on finance.yahoo.com for short dated put options on SPY.  Buy no more than 60 days out for expiration because you will pay more for the option the further out it expires.

Alternatively, probably what I would do given that the market’s downside is fairly, though not absolutely,  defined at Dow 7500, is construct a synthetic put by selling call options against the portfolio.  You can sell call options against each of your long stock positions: with volatility at all-time highs, the practice will  capture a large premium per position, as much as 10%.  This practice is called a synthetic put, or “covered call.”  If prices move sideways, it will have brought in a cash return on the portfolio while holding onto the current stock positions.  Try to sell the call options at 60 days or more to expiration in order to take in higher premium.

I like the latter because it allows the carefully chosen portfolio to hold onto otherwise strong companies even if the stock prices do not agree.  It minimizes the downside while avoiding liquidation or trying to time the market.  Clearly, if a portfolio is down substantially, it will take huge returns to get back to even, but blue chip stocks that have taken a beating will be among the first to roar back when the time is nigh.

The first strategy is mildly bullish, the second strategy benefits from short term sideways noise, the likely scenario for months to come.

- Wayne Weddington