How To Play This Risky Market
The $600-a-week in extended pandemic unemployment benefits is slated to expire July 31. The $2.2 trillion CARES Act authorized this money and it’s credited as one of the key factors in keeping the economy from imploding in the second quarter.
Of course these benefits have come at a cost. Many Republicans objected to this extra benefit as overly generous. Further, it adds to the federal budget deficit.
There is some truth to their objections. I personally know of several people who were making more money drawing unemployment than they would have made by returning to work. We shouldn’t create incentives for people not to work, especially when it drives up the deficit and pushes the problem to our children. That is a losing proposition and it has caused contention in getting a second fiscal stimulus bill passed.
As of this writing, the new stimulus package is stalled on Capitol Hill, with both political parties far apart.
Congress may quickly come up with a compromise, but the imminent loss of these extra benefits has driven up the market risk.
After releasing quarterly earnings, JPMorgan Chase (NYSE: JPM) CEO Jamie Dimon sounded a warning. Dimon said “The word unprecedented is rarely used properly. This time, it’s being used properly. It’s unprecedented what’s going on around the world, and obviously Covid-19 itself is a main attribute.”
Dimon noted that even though the economy is in recession, it doesn’t feel like it because the $2.2 trillion CARES Act injected billions of dollars into households and businesses. This helped mask the impact of widespread closures. But as some provisions of the law are now being phased out, true pain may be at hand.
It seems likely that the generous unemployment benefits will be drastically scaled back and that will hurt the economy. This raises the risks for investors. So, what should you do?
This depends on your circumstances. For risk averse investors at or near retirement, it may be a good idea to sell some of your riskiest investments. I certainly don’t recommend trying to time the market. Don’t sell investments just to try to buy them back cheaper later. Only sell if you plan to allocate the money into lower risk investments.
Buy Some Insurance
If you are holding investments that you deem higher risk, you can buy put options to help insure against deep losses. Let’s take Apple (NSDQ: AAPL), for example (although you can do the same for most companies). Last Friday Apple shares closed at $370.46. They have gained 25% year-to-date, and let’s say you want to protect some of those gains, but you don’t want to sell your shares.
In this case you could buy a piece of insurance called a put. A put allows you to sell your shares at a predefined price on or before a defined expiration date. For example, if you are really worried about a collapse in the market, you could buy a “Nov 20 2020 310 Put” for Apple as I write this for $8.05 a share. What that means is if shares are below this level on or before November 20, 2020 the owner of the put is still obligated to pay $310 a share for them. The premium for that put amounts to 2.2% of the current share price.
Of course you can insure your shares to protect much greater gains, but the premiums will be much higher. Increasing the strike price of that put to $370 increases the premium to $26.30, or 7% of the current share price.
You also can execute a stop-loss order on the shares, but a challenge with those is that normal volatility will often trigger the stop-loss (and lock in a loss). I prefer not to use them.
If You Are a Bargain Hunter
However, you may be a bargain hunter, looking to buy if shares plunge. You could put in a limit order to buy shares on a dip. Again, using the example of Apple, you could put in a order to buy shares if the market crashes that far.
I prefer an alternative. I would rather sell a put and collect a premium while waiting to pick up those shares. In this case, I could sell the “Nov 20 2020 310 Put” and collect that premium of $8.05 a share from the first example. If shares are below that level on November 20, I am obligated to buy them. That would represent a discount of 18% from last Friday’s closing price (including the impact of the put premium).
There are two caveats with this strategy. First, one option represents 100 shares. Thus, if you sell this put, you need to have $31,000 set aside in case it is assigned.
Second, there is no guarantee that you will be assigned shares. In fact, for a put with a discount that steep, you probably won’t. But you got to collect 2.2% on your cash in four months. That handily beats what you would get in a money market. And if shares do get assigned, you picked up your Apple shares at a big discount to today’s price.
Give some thought to how you will cope with increased market volatility in the months ahead. Hopefully, Congress can come up with a targeted, efficient approach that can keep the economy from imploding in the months ahead. But just in case, you want to think about your approach well before volatility returns.
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