Since when does killing another country's General constitute an act of war? While no one is shedding any tears for General Suleimani, he was a General in a foriegn nation and we did assassinate him and Iran has said they WILL retaliate – which could mean anything but you wouldn't know it from yesterday's markets – which made a quick recovery.
The S&P 500 is back at 3,245 and only about 15 points off the all-time high while Apple (AAPL) is testing the $300 line and Google (GOOG) is testing the $1,400 line – both at all-time highs as well. Google is being investigated for Anti-Trust Violations but so what, Trump is being investigated for Treason and that doesn't seem to stop him. Another unstoppable stock under investigation (Privacy Violations) is Facebook (FB) who are also just under their all-time high so of course the Nasdaq is doing well – closing in on the 9,600 mark that we said would be the top of the rally back in April, when we reviewed the top components, but 9,000 is going to be a real test for the Nadaq 100 as even the Nasdaq Composite has paused under 9,100 with the 200-day moving average now 10% below that mark.
Notice the cute indicator that the Nasdaq divided by the S&P is now 2.79 and it never quite hits 2.80 and lat time we were this high was back on 2018, before an almost 2,000-point (20%) correction. So we still like the Nasdaq Ultra-Short ETF (SQQQ) as a hege and SQQQ is way down at $21.45 – down from $80 a year ago. It's a good way to hedge the war and to hedge earnings season.
When we set up an index hedge, we like to offset the cost by selling puts against a stock we'd REALLY like to own if it's assigned to us and, back on Novemeber 15th, we put out a Top Trade Alert on China Telcom (CHL) at $39, thinking it would do better when the Trade War ended and it did but it's still only at $41.37 and you can still sell the June $42.50 puts for $2.70, which nets you in back at $39.80 and that's an entry we're comfortable with (see our Top Trade Alert).
So, as a new hedge, I like:
- Sell 10 CHL June $42.50 puts for $2.70 ($2,700)
- Buy 30 SQQQ March $20 calls for $2.55 ($7,650)
- Sell 30 SQQQ March $24 calls for $1.30 ($3,900)
That's net $1,050 on the $12,000 spread so, if SQQQ is over $24 into March expiration, you collect $12,000 from the spread and wait to see what, if anything, you owe back on the short puts into June. The overall upside potential is $10,950 (1,042%) and that should protect a $100,000 portfolio from a 10% drop very nicely but our true goal is to MITIGATE the damage, not completely cover it – as that's simply too expensive as a habit.
Why does that work? Well if you have $100,000 and can buy $100,000 worth of stock now, that's fine but if your money is in the stocks and the market falls 20% (uniformly), then you have $80,000 if you cash out, right? Now you need a 25% gain just to get even. On the other hand, if you have a hedge that pays you $10,000 when the market drops 20%, you then have your $80,000 in stock and $10,000 in cash and the stocks you can buy with your $10,000 are 20% cheaper so you can buy what was (before the correction) about $12,000 worth of stock for $10,000.
Either way, now you have at least $90,000 in stocks and a 10% rebound will put you right back to $100,000 while the unhedged portfolios will only be at $88,000. That's going to give you a MASSIVE difference in portfolio performance in a down market while a hedge like the one above only costs us $1,050 if all goes well with the short puts so maybe 10% of a 10% move up is lost (and it's cheaper to roll than initiate a spread as they mature).
The S&P 500 gained 30% last year and, while we certainly got sick of losing money on our hedges – they were the reason we were brave enough to stay invested most of the year and we had some very nice upside returns. Sure we could have done better if we didn't hedge – but that's an historically silly attitude to have – it's always better to hedge your bets – at least a little.