Wednesday, December 26, 2018

A valuable insight about volatility and some 2019 investment ideas

The holiday season leaves me lot of time to scour the newspapers, read and think about investments (apart from family stuff). There is also lots of time to focus on my health and so I gave myself a Fitbit watch for Christmas. I started using it the moment I left the store though, leaving an empty unwrapped box below the tree.

First about Fitbit, it is everything I need in a smart watch (monitoring my exercises, my food intake and daily activities) and more. It also notifies me if texts or calls come in on my cell, which I usually have on me or is within Bluetooth distance. My watch was around $250 dollars and it can be kept on when swimming. It doesn’t keep track of my heartbeat when swimming only of the laps I swim and as such, I do that counting in my head anyway. The thing does motivate me and that is very useful.

I am a value man and as such Fitbit is great value and certainly so when compared to Apple prices. We may wonder about the prospects of companies such as Fitbit but seeing what the watch is doing for me and their slightly more attractive designs from just a year or so ago and I think this may be an investment trend to watch.

Now to more important things, the stock market. I came across this Globe and Mail article (I read now 4 news papers per day on-line: two in Canada; one in the Netherlands and the Wall Street Journal). Surprisingly, a lot of my ideas come from the Globe.  The National Post is mostly for opinions that agree with me and thus it strokes my ego but not my objectivity. The Wall Street Journal is to get a better U.S. perspective after all, those guys in the south are all mini-Trumpies much dumber than us smart Canadians! Although… they do economically and in terms of stock market performance better than us for nearly a decade!
This article made a fundamental observation. Short term the market is emotional, if not hyper-emotional but long term the fundamentals count. Duh! You may say but hold on (I need another cup of coffee). The article also pointed out that only 10% of trades are based on corporate fundamentals and small investors. 90% is from Hedge funds, Algorithm trading and Hi-frequency trading… oh and ETFs.
You’d say that all this ‘professional trading’ is objective but then you miss the boat entirely. Remember my posts about benefitting from volatility? Well other than ETFs all those guys need volatility to make money. If there are four poker players: Algo, Hedge, Hi-F and ETF who is the patsy?  ETFs of course because that is where many small mom and pops and active managers put a lot of their money and they react often emotional.  Especially during markets of the holiday seasons when trading volume is light. This and tax loss selling propels volatility. That is what the three other players live off!  So they will do anything to create even more volatility! When you trade options, the best premiums you can get is during volatile markets. The best deals you can find is during volatile markets.
All those algorithm trades don’t follow fundamentals but technical indicators such as head-and-shoulder patterns. Momentum. By analyzing these patterns, they all follow the same movements and often their trading behavior anticipates many of these short term moves. They position themselves in micro-seconds to take advantage. That is what really is going on! The small investor plays only such a small proportion in these emotion exaggerating markets and the rest is ‘Fake’. Unless you recognize what is going on and become the contrarian who buys at market extremes – especially lows.
Right now, you can do lots of things such as writing a put option on Hershey for $100 while it trades at $103.5 dollar U.S. One ‘put’ contract is a commitment to buy 100 shares; in this case 100 Hershey shares if the price falls below $100 (strike price) something you always dreamed of owning. Selling the put that expires on February 15, 2019 pays you instantaneously $285 dollars.  You must have the means to fulfill the commitment: buying 100 Hershey for $10,000 cash. Not considering your credit capabilities, you will need $10,000 in cash plus $10 in commissions to execute the sale of these puts.
What can happen? 
  1. The market and Hershey shares are up by February 15 and you made $285 or $2.85 per share that you never owned. If you count the cash commitment, you’d made 2.85% in 1.5 months or nearly 23% annualized! (If you did 8 more trades like this you'd make in 2019 U.S. $ 2,280) 
  2. The market doesn’t change, and you made $285 or $2.85 per share plus the opportunity to sell another contract for nearly the same price. If you count the cash commitment, you’d made 2.85% in 1.5 months or nearly 23% annualized!
  3. The market falls further and by February 15 you must buy 100 shares of Hershey for a price you loved to own them anyway $100 and you made already $ 2.85 per share in option premiums! Thus your actual cost of buying is $97.15 per share. Wow! But now you must wait for the market to recover. But even if it doesn’t go back up what was your alterative?
You would have bought Hershey for $103.50 at today’s tempting prices. You'd spend $10,360 (including commissions) today and in February your shares would be worth $10,000 or less!  What the put did was reducing your risk by 103.5-97.15 = nearly $6 or 6.13% compared to today’s immediate purchase.
So you win anyway, especially since chances are very good that the prices will recover from todays emotion-enhanced low prices! Would you take advantage of a deal that has nearly a 90% chance of working out for you?
Even if you follow my idea of Benign Neglect (previous posts) and just do nothing; the insight that these trading institutions are exaggerating market emotions may give you the confidence to stay with your Benign Neglect strategy and ignore today’s market movements because just like your house, your stock investments will likely go up in the years to come as long as you hold on and don’t sell in a panic. Because those losses from a panic sale you can not recover!

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