There is a silver lining in having a bad day: Bad days usually are followed closely by really good days. In looking at the Dow Jones Industrial Average (DJI) over its history, half of the 20 largest single-day gains came within 12 days of the largest down days. Almost all of the largest up days came within 90 days of the largest down days.
For example, on Oct. 13, 2008, the Dow ripped upward by 936.42 points — in the midst of the 2008 market crash.
There are several important implications that can be derived from the close proximity of market good days and bad days:
* Unusually large up- and down-market movements occur in close order because they reflect an investor base that’s trading stocks on extreme fear and emotion.
* High volatility is a two-edged sword. The market and individual stocks can be volatile up as well as down.
* You may find some surprisingly attractive times to exit open positions. If you have some time before expiration, and as volatility rises (the price that people are willing to pay for options), your long positions may helped, all else being equal.
* You can lose big by shorting stocks or overpaying for puts.
* Because fundamental investing principles (price-to-earnings multiple, growth outlook, balance sheet metrics, quality of management, pricing power, etc.) have little bearing in the short term, and because market movements can be exaggerated, reducing exposure and going to cash is almost always the best answer.
* When the VIX shoots skyward, almost all asset classes begin to move in the same direction. Diversification as a means of portfolio protection becomes less effective.
Exercise Options Intelligence When the Market Drops
One of the most important rules of successful investing is to stick with what you do best: Stay with your disciplined investing strategy.
Our strategy is based on following institutional options intelligence. We have a fairly strong record of finding winners by monitoring the smart money.
When the VIX climbs by more than 100% in less than a week, as it did in early May, options intelligence is replaced with options emotions. People buy puts en masse without much price sensitivity, expressing very little options intelligence. The options market becomes clouded by frantic hedging that distorts prices and causes the more targeted options investor to move to the sidelines.
When the signals aren’t there, we’d rather not force the issue. What makes us successful is that we follow a system we’ve been using for years. If the system provides few buying signals in the short term, we’d prefer to let that be our guide rather than to improvise with untested — and perhaps costly — methodology.
The Corporate Tax Effect
Something else to keep in mind is that corporations pay taxes on the 15th of the last month of every quarter. When they pay their taxes, they draw down their money market accounts. If there are large draw-downs, it can mean large tax payments, which serves as a leading indicator for earnings reports.
For example, a spike in Fed funds rate and measures of money market flows can suggest large draw-downs in money market funds in the few days leading up to those tax days. And those indicators are positive.
When to Have a Quick Trigger Finger
Long equity options with near-term expirations will suffer immediately on almost any market pullback. Because of their sensitivity, there are times when we believe it’s prudent to have your quick trigger finger on the sell button. We’d rather risk giving away profit upside than risk total loss.
- Your Next Opportunity to Short the Market
- How to Protect Yourself From the Next Big Sell-off
- The Foolproof Way to Short the Market
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