What To Do If You Blinked And Missed The Stock Rally
In January, I wrote about the 'stealth' bull market. It was so stealthy that it ended as soon as I gave it a name. Now we've experienced another bull market. I'm calling this one the 'Road Runner' rally. It went by so fast that it seemed a dizzying blur.
From March 9, when the Nasdaq Composite closed at 1269, to March 26, when it hit 1587, the index rose about 25%. The Dow Jones Industrial Average and the S&P 500-stock index each rose more than 20%, the traditional definition of a bull market. This remarkable move required just 17 days, the fastest, steepest rally since 1938, which makes it the fastest bull market in my lifetime.
Then, on Friday, the averages plunged. Last week I mentioned that astute investors following the Common Sense system should be getting ready to sell something. Little did I know that a few days later the Nasdaq would indeed hit a Common Sense selling threshold, which is a 25% gain from the most recent low, or 1586. That selling opportunity was brief, and I was en route to Boston and couldn't take advantage of the opportunity.
This is the second such brief opportunity this year, the last being in January. Then too, I wasn't in a position to take advantage of it. Like most people, I don't sit glued to a screen with stock quotes; I don't check the market every day let alone every hour; and my system isn't designed for split-second market timing. If that means missing a few signals in my system, so be it. I call these thresholds opportunities, not obligations, though obviously there's no point in having a system if you don't make a good-faith effort to follow it.
There's also something a little unsettling about markets that move at warp speed. We've experienced the dizziness of free fall; now we've been getting a taste of the equally fast ascent. It reminds me that there's a reason I don't seek out the thrill of theme-park roller coasters. A 318-point upward move in the Nasdaq in a matter of 17 days is clearly unsustainable, if not quite a mathematical impossibility. While I would have appreciated the opportunity to raise a little cash last week, Friday's drop actually came as something of a relief. Another rise would have seemed manic, merely setting investors up for another plunge.
Volatility remains high, which has yielded these recent buying and selling opportunities to those following the Common Sense system. Traders love this, since such swings yield higher profits, especially in the short term. I'm not a trader, and I'd be happy with fewer such opportunities. I can remember years that yielded just one or two. Nevertheless, this is the world that confronts us. We might as well take advantage of it.
The standard measure of volatility is the VIX, or Chicago Board Options Exchange Volatility Index. When the index is high, investors expect a high level of volatility. For years the index rarely breached 20. Though it has receded from its extreme highs of last fall, it's recently been trading in a band of 40-50. The index is misleadingly labeled the 'fear index'; since the volatility could as easily be on the upside, it could also be dubbed the 'greed' index.
Apart from a broad market indicator, I find the VIX is a useful guide to the premiums investors might expect to be priced into options. When the VIX is high, options are expensive. Just like stocks, I like to sell high and buy low, so when options prices are high, I tend to be a seller.
Last week I mentioned a strategy called 'covered calls,' which involves the simultaneous purchase of a stock and selling calls of the corresponding option. Given the recent selloff, that's proven to be a good strategy. While stock prices may have dropped, so have the corresponding options prices. When you write a call -- which conveys the right to buy shares at a specific price for a specific time period -- you receive the cash and your account statement reflects an offsetting debit, which declines as the option price drops. It's extinguished altogether if the option eventually expires worthless.
Over the years I've found it's also an effective strategy to sell calls on stocks I already own when the Nasdaq Composite hits one of my selling thresholds. That's especially true if the VIX is elevated and the rally is still in its early stages, both of which are true now. Selling calls gives investors immediate cash as well as the potential for further gains in return for capping those gains at the strike price.
Selling covered calls is a conservative strategy for reducing risk. I never recommend selling calls on stocks you don't own -- so-called naked calls -- since you might be forced to deliver those shares at very high prices. Selling a covered call caps your gains; selling naked calls exposes you to potentially unlimited losses.
Given the brevity of last week's selling opportunity, I haven't yet had a chance to put this approach into practice. But when I missed the selling threshold in January, I said I was confident another opportunity would present itself eventually. It did. I feel the same way now. And the next time the Nasdaq crosses 1587, maybe it will do so with some real conviction, and stay there for more than a few hours.
James B. Stewart, a columnist for SmartMoney magazine and SmartMoney.com, writes weekly about his personal investing strategy. Unlike Dow Jones reporters, he may have positions in the stocks he writes about. For his past columns, see: www.smartmoney.com/commonsense. |
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