It’s All In The Head

To a contrarian, bad news is good news. To my contrarian ears, good news is breaking out. Take the new book The Panic of 1907: Lessons Learned From the Market's Perfect Storm by Robert Bruner and Sean D. Carr. It talks about the strong parallels between the disastrous economic panic that brought about the birth of the Federal Reserve Act in 1913. The book draws attention to the many similarities of then and now. I love it. Not because it is going to give me any new, insights but that fear might be lurking around the corner. There's only one problem: too many people are talking about it. I say it's a problem because when fear enters the picture, real opportunity can't be far behind. But usually, when there's a lot of talk, nothing happens. But as an option trader, I like that, too. You see. being an option trader is so exciting because there are so many ways to play the game.

During this time of dark clouds appearing on many traders' horizons, it's wise to take some extra precautions but not to panic. For instance, if you have accumulated gains in your stock investments, you can benefit by using the stock option strategy called the"collar." In this strategy, you can protect your gains, ride out any temporary downturn caused by panic selling, and still make some money. Moreover, you can stay in the game and ride out the storm and be in position for a rapid rebound.

Case in point. During the 1987 market crash, most of the experts were out of the market, leaving us little suckers to take the big hit. But low and behold, the eggheads were left with egg on their faces as stocks quickly rebounded and left the experts on the outside as huge gains were reaped by the little guys.

Getting back to the collar. It's a strategy where a simultaneous entry is made into a covered call and a long put. A covered call is when an investor uses the underlying stock to sell ("write") an out of the money call and buy a put. If the market goes down, by properly hedging the long position with put options, profits from a declining market will offset losses suffered by the decrease in stock value. But why sell the covered call option?

When you write (sell) a covered call, you get paid a premium for each stock. If the call doesn't go into the money, then the call option will expire and the premium earned helps to offset the cost of purchasing the put position. This strategy is good to use in a climate like in today's markets. There is a lot of uncertainty and the hype may be laying the groundwork for a correction and maybe even a recession. As a contrarian, bring it on. But first, collar your gains or at least buy some downside protection.

One thing is starting to really influence my macro thinking. Most everyone-particularly the experts- don't seem to understand that money is not money anymore; its all about perception. We can indeed psychologically materialize a recession or a boom. If we think things are good, they will be. If we turn negative, things will reflect that. The "relative truth" might be that the numbers look bad, but the "absolute truth" might just be that if few are listening or believing, the facts may mean nothing. This may be particularly true when dealing with the miserable science of economics. So bless the option trader, for he has many ways to hedge, collar, straddle, spread, and otherwise tweak to the sentiment of the day. I say, intrepid stock option trader don't run scared, cover, collar, hedge and spread and wait for the storm to blow over....if there is a storm at all.