Yesterday I saw an interesting poll on Yahoo! Finance that asked, “With the stock market showing renewed strength is it safe to buy?” As of now, the results are as follows:
|Yes. We’ve bottomed.||28%|
|Stocks will trade sideways.||30%|
|No. This is a head-fake.||42%|
64410 Votes to date
It is rare for me to be in the majority, but I agree that this indeed is a head fake. It is a relatively well known fact that the biggest one-day gains in the stock market tend to happen during bear markets. It would seem the majority participating in the poll are either aware of this fact or are aware that the economy is still in a relatively poor state. I think as the year progresses, there will be economic reports that indicate the economy is either stalling or falling. I think there will be more pain to come in the stock markets.
Is there anything you can do to protect yourself? One thing you can do is buy put options to hedge against losses in any long positions you have. The problem is that everyone else is doing this as well, and it is driving up option prices/implied volatility. Just take a look at the chart for the VIX (CBOE Volatility Index) since October of last year, when the market indices reached all-time highs.
That means you will be paying a lot for any “stock insurance policies” as I like to call them, which will effectively lower your returns. If you’re in it for the long haul and you’re feeling bearish, you could always write covered calls and receive some income to help dampen any potential losses. Now would also be a good time to write covered calls because implied volatility is on the rise, which means you can receive bigger premiums. Of course, if I’m wrong and the markets do continue the upward trend, you could potentially be limiting your gains by writing covered calls.