Friday, December 11, 2009

When is Boring Good?

So, what do you do, right now, with your portfolio? The stock market is undecided as to what it's going to do. Joe Terranova, today on Fast Money Halftime Report, he told viewers never to sell a quiet market. That is exactly what we have in front of us...very quiet. We have been in this range for weeks now. So, now what?

If you are long only (for a definition of "going long" please see our YouTube Channel video on the subject to get up to speed. So, if you're a retail investor, we are very sure that you own few options positions (if any) and very rarely do you sell stock short. So, what can you do to protect all of your long positions? We have two ideas.

1) The VIX, is the measure of options action on the S&P. The higher the VIX, the greater the movement on the S&P that is expected. So a 20 handle on the VIX indicates that corresponding move in the S&P 500 index. As the VIX rises, you see wilder and wilder swings on the index. Now, it has been called the "Fear Index" and there is a trader on the FMHT Report that they call the "Fear Merchant" but those are really silly, uneducated characterizations of the VIX. What we do know is this, when markets decline, especially big, people place more options bets, more protection, more directional calls...and it sends the VIX UP! So, stocks down, almost always, VIX up. SO, you can buy iPath ETN that tracks the VIX! You can buy the VXX, which tracks the shorter term futures of the VIX. They have another product that tracks the VIX on a longer term...but we think there is a lot of noise in that product, so take a look at getting long the VXX as a way to protect your portfolio of individual stocks.

2) The Dollar is one of the most crowded trades ever. The stock market and the dollar are certainly at odds with each other right now. A weak dollar is terrific for US companies that export goods to foreign countries. So, if you want to make money when stocks go can own the US Dollar! Usually, with commodities, there is a "negative roll yield". This is just fancy talk that tells you every time the index is rebalanced, usually monthly or quarterly, then you lose a little bit of money as they roll those contracts (sell the current month and buy the next month contract). They have to roll commodities contracts because (like options) those contracts expire on the expiration date and they don't actually want to take possession of the actual commodity. This problem of a negative roll yield doesn't exist in the UUP (the ticker symbol of the Powershares Dollar ETF) because there is no cost to store dollars (as opposed to oil, corn, sugar, etc). This means that when you buy the UUP, you can really own in forever if you like.

One of two things will happen with the UUP. Either stocks will remain at odds with the dollar, and on down days, you'll see the dollar go up. Because so many people are short the US dollar, eventually those people will have to cover their short position by buying the dollar back at the then current market price. That could be ugly and you could see an amazing short squeeze (sending the UUP up huge). OR the dollar and the stock markets will decouple. This means that they can move in the same direction. When that happens, it means you can continue to own the UUP AND your stocks at the same time! So, we think, this may be something that you could hold forever. Essentially your only risk is political risk (which involves fiscal responsibility risk). Unless the US collapses, the dollar will always be worth something...and the people feel like the dollar will be much stronger in 5 or 10 years. A short covering rally in the dollar will certainly bring that to fruition.

There you go, two great ideas for how to protect a long only portfolio when you can't (or will not) go short or own options!

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