Is It Time To Hedge?

As we remain in one of the strongest bull markets ever, is it time to hedge? Whoever has tried to short the market this year or for that matter the last nine years understands this has not been an effective strategy to say the least. However, as we are now entering the height Q3 earnings reporting season and as I mentioned in my previous blog implementing a hedge strategy could provide continuing beta should the bull market carry on yet offer profits in the event stocks or indexes go down. The strategy I am referring to is an options strategy called a “straddle”. A straddle is when an investor buys a call and a put option with the same strike price and expiration date with the selected strike price as close as possible to the current stock price of the underlying asset. Let’s take Intel as an example: Intel (NasdaqGS: INTC) closed on Friday at $39.67 and is scheduled report their earnings results on October 25th. Taking a look at the November $40 strike price on Intel, the call option is approximate $0.83 per contract and the put option is approximately $1.34 per contract. So if an investor/trader decides to put a straddle on Intel at this particular strike price, the total cost of the straddle is $2.17. You arrive at this number by simply adding up the cost of the put and call option. Where you profit from this trade is if Intel trades north or south of $40 by more than the total cost of the trade and before expiration.

One of the reasons why straddles can be effective during earnings reporting season is that earnings can be a huge catalyst for stock price movement. This especially rings true when a company surprises to the up or downside. With a straddle it does not matter which direction the underlying asset moves, so long at it moves greater than the total cost of the straddle. The risk with the straddle is if the underlying asset does not have a big move in either direction before the straddle expires. Options do have an expiration date so you have to make sure that the catalyst occurs before the expiration date and even then allow yourself time for the full potential to play out. I also look for the historic movement of a stock or index to see if it does move greater than the cost of any given straddle regardless of a “catalyst”. That said, options and options strategies are extremely risky and volatile and you should always consult with a certified financial planner before considering any new strategy. Good luck to all 🙂

~George

Russell 2000 – All Time High!

So now the small-caps join in! The Russell 2000 (chart) closed the week at an all time record high of 1490. For most of the year the widely followed small-cap Russell 2000 has lagged the other major averages. Now it has broken out, see (chart). In fact, when you look at the chart of the Russell, one can say this index has gone parabolic. The Nasdaq (chart) and the S&P 500 (chart) also closed at their all time highs on Friday, while the Dow Jones Industrial Average (chart) posted yet another positive week. What’s more is the month of September is typically one of the weakest months of the year for equities losing on average of 1.5% happening 70% of the time since the 1970’s. Not this year, in fact there have been so many record-breaking closes on all of the aforementioned indices it’s hard to keep track.

Question is, now what? With the third quarter of the year now in the books, Q3 earnings reporting season is right around the corner. I have got to believe with the Federal Reserve closing the chapter on their quantitative easing policy and now taking those assets off of their books, plus interest rates scheduled to rise, investors should pay closer attention to the health and growth of corporate earnings. Do you remember the days when earnings and earnings growth actually mattered? Well those days may be back upon us. Hence, the report cards that come in from corporate America may actually move the markets in a fundamental way. This we have not seen in almost a decade. However, if the market momentum that we have experienced since the election continues, and investors ignore the fundamentals, then why couldn’t we end the year at even higher highs?

One thing for sure is October will be filled with many catalysts that should bring in some volatility and a lot of opportunity.  Between now and year end may be the time to implement a hedged strategy where one can potentially profit regardless of how the indexes or individual stocks react to what’s ahead. I’ll cover this in my next blog. Good luck to all. 🙂

~George