Are You Prepared For A Market Crash?
I logged into my brokerage account last Friday and saw that most of my positions were down for the day. Some were down substantially. I was surprised, because Friday was a shortened trading day, and I assumed there wouldn’t be a lot of activity.
Boy was I ever wrong.
Flashes of Spring 2020
I quickly discovered the issue. A new, heavily-mutated variant of COVID-19 first detected in South Africa last week has been detected in Israel, Hong Kong, and several European countries. The world suddenly had flashbacks to the spring of 2020 when the COVID-19 pandemic first panicked the markets.
Oil prices plunged by more than 10% on Friday. It was the largest daily drop since April 2020. The stock market had its worst day of the year.
The good news is that if your primary concern is gasoline prices, relief may be on the way. The bad news is that this is not the way you want relief from gasoline prices.
The stock market has performed very well this year, and that can lull investors into complacency. This volatility spike is a good time to ask yourself if you are positioned for a repeat of the 2020 crash. It’s far too early to suggest that a repeat is in store, but it’s always good to be prepared for that.
What should you do?
First, make sure your portfolio isn’t over-leveraged. I don’t recommend buying stocks on margin, because a market crash can decimate your portfolio. When you are heavily margined and the market crashes, the margin calls start to come. Then your positions get sold out from under you. There is no riding through volatility when your positions have been sold.
Second, identify any funds that you expect to need in the next two to three years, and make sure they are in a secure place. The market bounced back quickly after last year’s crash, but there have been plenty of times that it took years to recover from a crash. Any short-term funds that you expect to need shouldn’t be exposed to the volatility of the stock market.
Finally, if you fear a crash, there are a couple of option strategies you can use to reduce your risk. One is to buy a put as insurance. An investor who buys a put is buying the right to sell their shares (in 100 increment lots per contract) at a defined price at which the trade would be executed (the strike price) and a defined date by which the trade would occur (the expiration date).
The person buying the put is either betting the price will go down, or buying insurance against shares they own just in case the price collapses. For example, someone who owns shares in a company trading at $150 a share might buy a put with a strike price of $120 just to ensure they can still sell their shares at least at that price.
But a put costs money. I prefer a different strategy. If you sell calls against your positions, you will collect a premium and reduce your cost basis. It doesn’t protect you against steep drops, and you potentially limit your gains, but over time selling calls on your positions can steadily reduce your cost basis, which reduces the pain of market declines.
For the most part, though, you should just continue to execute your plan. Don’t sell in a panic. Position yourself to ride out a market crash without breaking a sweat.
Editor’s Note: One of the best ways to protect your wealth (and still reap gains) is to tap into megatrends that will unfold regardless of the unpredictable path of the pandemic. One such trend is the transition toward electric vehicles (EVs).
But the smart money isn’t limiting itself to the mainstream EV stocks everyone is raving about. They’re quietly diving into what savvy investors call “the EV shadow sector.” Click here to learn more.