After gaining 27.4% in 2013, the US S&P500 index far exceeded industry expectations, let alone Mum and Dad investors. During a period where annual GDP growth rate is 2.5% (as at March 2014), the expectations for the stock market to gain another +27% return on the year is extremely low. And in light of recent economic data out of China, fears of a stock market crash have again started to influence investor confidence. So let’s take a look at 3 investment ideas that will help you make money if the stock market falls.
Year to date (as at 18th March 2014), the S&P500 index has gained 24 points or 1.3%. It had reached a high of 1,885 or 2.0%. This isn’t the same exciting momentum of 2013 which during the same period had gained 102 points or 7.0%.
The fact that we had seen the S&P500 falling 113 points or 6% during the stock market fall in Jan/Feb has helped to slow the momentum of the broader upwards trend. Could this be a warning signal, or was it merely a counter-trend movement?
If your view is that the slower stock market momentum has a strong potential for a weaker stock market through the remainder of 2014, then you need to start considering how you will make a profit should the stock market fall. You cannot merely rely on the ‘hope’ that it will continue to gain 27% per annum.
So let’s take a look at our top 3 trades to profit if the stock market crashes in 2014.
1. Buy Index Put options to protect long-term investment portfolio
If you have an investment portfolio where selling the shares is a last choice (whether that is due to tax reasons or any other reason), then a stock market crash is going to hurt your portfolio capital value. No matter how good your dividend yield might be, a stock market crash will hurt the long-term investor.
A Put option gives the buyer the right, but not the obligation, to Sell shares at a set price, on or before a set date. It will cost you a premium to buy this Put option, however, if the stock market falls significantly, then the gain in the Put option will help offset the capital loss in your stock portfolio.
So for example, let’s say we have a $100,000 portfolio of Blue chip shares, and the S&P500 index is trading at 1860 (as at 20th March 2014). We could purchase a Jan2015 1850 Put option @ $101.00 per share. To protect our $100,000 portfolio, we would need to purchase 1 option, which will cost us $10,200 in premium or 10% to protect our portfolio until January 2015.
If the stock market falls, the value of this Put option will rise. It can then be sold for a profit to offset the declining value in the share portfolio. If the stock market rises, the value of this Put option will fall. Instead of just letting this position run through to Expiry to become worthless if the stock market continues to rise, you could define a point on when to exit, and recoup as much of that premium as possible.
Be aware, you will not be able to completely ‘hedge’ or offset the decline in portfolio value simply by purchasing a Put option alone. However, if you
2. Adopt Bearish Option strategies
The Options market provides various strategies that can benefit from Bullish (up), Bearish (down), or Sideways market activity. Some strategies will profit from Time Decay, changes in Volatility, or directional movements. Options are an exceptionally dynamic means to establish a strategy or various strategies, to help reduce Risk and capitalize on your view of the stock market.
During a stock market crash, most stock prices are falling. Panic drives long-term investors to sell their stocks, usually after there has already been a significant shift in prices. Option volatility increases, which pushes option premiums higher.
While you may not want to invest your entire portfolio into Option strategies, choosing to maintain your long-term stock positions, diversifying your portfolio to include various strategies that will benefit from Time Decay (time is guaranteed to pass), or changing Volatility, will help to create a return during a stock market crash.
Some of the key strategies you may like to investigate include:
- Put Diagonal spread
- Bear Call credit spread
- Bear Put debit spread
3. Cash in – reduce your stock market exposure
Many investors forget that cashing in your investment portfolio is a very sound method for approaching a stock market crash. Of course, if the crash has already occurred, you may be too late. So you need to define whether you believe there is more downside Risk to come.
If the stock market were to fall say 30% in value, then it is a reasonable expectation that your stock portfolio could fall a similar percentage. But a stock market crash just doesn’t occur at all time highs. History has proven that the stock market will decline mildly before a crash occurs. Whether that is the 1987 stock market crash, the 2000 Technology Bubble, or the more recent 2008 Global Financial Crisis.
Should you find that the stock market has decline +10% and your view is that there is a strong fundamental or economic reason for continued downward activity, cashing in your share positions could save you a lot of stress and capital value if the stock market were to continue falling.
Remember, you can always buy back into the same stocks, or different ones, when the dust settles and stocks are at cheaper prices. Especially if your view of the company remains the same as when you had owned it previously.
Be aware that selling long-term share holdings may incur capital gains. Therefore, you will need to source the advice of a qualified accountant to establish how this may affect your financial situation.
Matthew Brown – US Stocks & Options specialist
US Equity & Option Client Advisor
Halifax Investment Services
ASIC Australian Financial Services License Number – 225973
Matthew is an Authorised Representative of Halifax Investment Services (Halifax). Halifax provides broker services, including Full Service and Discount Services using multiple trading platforms.