And I say it is a disadvantage because when the markets rally really hard, you are inevitably left behind with a sub par performance.
It becomes even more challenging after a sudden down move. You suffer losses to the downside, the market does too, so no issue up to that point. But then if the market recovery is strong, you, as a credit spreads trader, just get your small wins, while the market gets to recover the losses much quicker.
Based on this observation, and the fact that we are in bear territory, I will prioritize my long term investment activity over credit spreads trading in this environment.
We were recently down 27% from the peak. I have been deploying some cash in long term investments but would like to add more. How low will the markets go is anyone’s guess. But a look at bear markets since World War Two gives us some guidelines as to how bad things can get:
The Median bear is -31% from the peak and 15 months to reach a bottom.
The worst case is -56.8% with two other cases close to -50% peak to trough.
In terms of depth we touched -27% already. In terms of length, we are barely one month into this.
It looks like we are headed to a recession, and I feel there is no rush to deploy capital tomorrow. It is not that I have much cash sitting idle at this point anyways. So, this will be a good time to accumulate as much cash as possible.
If the S&P500 hits 2000, that is 41% down from the peak. I don’t think you need to wait up to that point to start investing. In fact I already started nibbling. But that is a point where I would invest with confidence that the worst should be behind.
Now, if the S&P reaches 1700, we are talking about practically a 50% fall from the peak and roughly an 11 Price to Earnings ratio for the market as a whole at that point. At that level of undervaluation, I would invest very aggressively for the long run. Even using more aggressive stuff like SSO (double leveraged SPX) and hold for 10 years. Of course the most aggressive the investment, the smaller the dollar amount to allocate to it.
For option traders, I would also consider a long term Bull Risk Reversal, which is a combination of a Short Put that finances a long Call.
Just to illustrate (not that you should do this right now), but just for illustration purposes:
Using June 2021 options (to give ourselves some time for a sustained rebound), we can sell the SPY 200 strike Put for 13.97 (mid price) and Buy the SPY 310 Call at 11.07 debit (mid price again).
As a result you obtain a credit to your account of 2.90 ($290 dollars for playing 1 Put and 1 Call) and you have a strong bullish exposure via the 310 Call option and the short 200 Put. If at expiration in June of 2021, the SPY is between those two numbers 200-310, then you just made $290 dollars. If the markets rally hard, you make a killing.
Now, this play is not for everybody. It is very aggressive and I also assume the willingness to take SPY stock assignment if by expiration, the SPY is below 200 (equivalent of S&P500 below 2,000). Because of the 2.90 credit received, if the assignment at 200 happens, my real cost basis is 197.10 for 100 shares of SPY. If one is willing to hold SPY shares at 197.10 for the long run, as a long term investment, there should be no problem with this play.
A 100 share assignment of SPY stock at $200 means $20,000 dollars of capital (half of that in a US margin account). Also, just to enter the options trade, the broker will freeze some margin capital in your account. As of now, ThinkOrSwim tells me that it would freeze $3,118.30 in buying power. Tastyworks is saying $3,109.31. So, definitely not for every body, but it is something that many (me included) can consider.
A position like this one can become way more attractive at lower market prices. I pulled the above numbers after Friday March 13 close, when the S&P500 closed at 2,711.02. But just the day before, March 12 when the S&P closed at 2,480, it could have been the 185/290 June 2021 SPY Bull Risk reversal for 1.45 credit. A much lower assignment point (SPY 185) and also a much lower Call strike price of 290 not 310 (meaning market doesn’t need to go as far up as before). Of course it can get even more attractive at lower market levels.
You can also play a pure straight forward long Call option. I just don’t like this alternative a lot right now because all options are too expensive due to the super high volatility. As the markets move up, the VIX would crash, eroding the value of your Call option in the process. Yes, it wins via directionality but loses some due to the reduction in volatility. That’s why I like the addition of the sell of that overpriced Put.
You can also consider long term investments in selected companies. These are some of my favorite American names in no particular order:
MSFT, V, HON, AAPL, DIS, PG, JNJ, LMT, MA, NKE, O, PEP, SBUX, COST, JPM, TXN
In Canada I like the telcos, Telus (T.TO) is my favorite. Banks too, TD is my favorite along with the Royal Bank RY.TO. Canada National Railway (CNR.TO) is one of my all time favorites. Add a couple of utilities, EMA, FTS. All those at the right price can offer nice returns and dividends in the long run.
If you just happen to hate individual stock picking, you can go with the indexes directly. SPY, or VYM (which is the Vanguard High dividend yield ETF), etc.
Picking the exact bottom is impossible. Also unnecessary. It doesn’t need to be perfect, just long-term effective. Because we will never pick an exact bottom, there will be pain to endure. Those investments are very likely to show some losses for a while. So, you need to be mentally ready for it and not bail needlessly. Whatever strategy you choose, only apply it when you have the conviction, while also deploying a capital amount that you are not likely to need to touch to cover living expenses in many years. This will give you the necessary ‘staying power’.
We have interesting times ahead and perhaps a life-changing opportunity that will be cherished a decade or two from now.
It is sad that people are dying because of COVID-19 and that many others are likely to lose their jobs as a result of a recession. If a recession finally happens and the vaccine is, as most experts say, months away at this point. But that’s outside the control of us, mundane, small investors. We must be strategic and plan ahead with a cold head. Determine how we will protect our investments and how we can improve our financial situation for the future of our families. It is better to do so, in moments like this one: during a weekend, while emotions are not rolling and before the panic in the markets and the media cloud your judgement.
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