How to Use Options in an Uncertain Market

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By Kevin Hurley

What Happened to Our Santa Claus Rally? History tells us we should be seeing a “Christmas Rally” gain.  Historically from November 28th until January 4th, we should see an estimated median average return of .8 to 1.5%. 

There seems to be a lot of positive catalysts out in the trading community if you are a fundamental trader.  We just finished an election, and election years have traditionally seen a significant rally into the end of the year. Plus, we're seeing better than expected homes sales, strong retail sales, and improving employment numbers. No one can argue that a 7.9% unemployment rate is much better than an 8.1% unemployment rate. Moreover, this is the first time in years we are seeing expansion in China in the manufacturing sector (depending on whether you believe the reported numbers out of China).  This should be a time of year when we invest in the market and make money no matter what, right?   Unfortunately, that is not happening.

Why?

As I scan the skies for a man in a red suit, sleigh and eight reindeer, I see only red numbers on my trading screen as stocks seem to be selling off.  Fundamentally, I am invested in strong companies that have made money throughout the year.  I watched the November pullback in most indexes and thought institutional money sold off early.  Pullbacks are healthy and good for a market.  Pullbacks are the precursor to another bullish leg up in cyclical bull markets.  Wasn’t it supposed to be a sleigh with a lead reindeer having a bright red nose? I can handle some red on my trading screen when I feel comfortable that the positions have a chance to come back.   Using options to hedge stock ownership can be a great way to make it through a pullback in the market.

Let’s talk sentiment for a minute here in December. Sentiment can be defined as the amount of volatility in our market.  Volatility is uncertainty in our market.  It looks like market certainty could be a long way off.  This can make trading very difficult. 

What can you do in an undertain market?  Use options to hedge your stock positions.  Long puts give you the right to sell stock at a certain price for a certain period of time.  A protective put strategy allows you to be protected to the downside if the market doesn’t like the fiscal cliff resolution.  Maybe adding a short call position to create a small credit in the account.  That credit can give you a little bit of downside protection and a little time to decide if further action is required.  In todays’ uncertainty I know two things about our Christmas Rally.  I don’t want to miss it when it comes even if it is a month late.  I also know I don’t want to be in a hope mode with long equity positions without having an options hedge in place.

 

 

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Options , Economy , Stocks

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