Time to sell?

Voyager2002

The similarities between the current market and that in the run-up to the great depression is uncanny, if not alarming. But of course, this time it's different!

http://www.marketwatch.com/story/scary-1929-market-chart-gains-traction-2014-02-11

atush

It isn't the same to me.

Sell if you want to, don't ask us to validate?

Averaged

Except it's not the same

http://www.thereformedbroker.com/2014/01/29/games-people-play-that-1929-analogy/

Charts, as always, show just what the creator wants to show.

The key issue to recognize here is the scale. When you overlay the charts, but don’t normalize them, they look very similar. When normalized, however ... we can see they look quite different. From 1925-1929 the INDU was up over 230%. From the 2009 low to the 2013 high, the INDU was up 156%. So the rally in ’29 was much more significant prior to the decline.

jamesd

Also consider that the index is the Dow, possibly the worst of all global indexes because it has a limited number of stocks weighted by their price, not company value like more modern indexes.

US stock indexes are at quite high levels and it might well be quite a good deal today to buy some options to make money from a drop or just to reduce net exposure to the US market. I've been considering buying a bit in a doubly leveraged short US tracker ETF to reduce the net US exposure I have in a global tracker fund. Haven't done it yet, though.

BeatTheSystem

Hmmm, I have been pondering if we are in for a correction. But hey sod it, I'm all in. One can spend too much time worrying about what might happen. I am 'hoping' that for the next 2 or 3 years the markets are going to climb on the wall of worry.


Always risky making this statement, as next week there will be a crash and someone will ask, 'how's the portfolio doing!!'


Looking at the ftse it is peaking similar to it did in 99 and 07 and just looking at the chart one might think we are in for another significant down phase - some of my associates take this view, others are with me.


I expect a minor correction but don't think it will be a long one. My personal opinion is that in the next couple of years there will be a series of new highs being tested along with minor pull backs.


However I am now only putting new money into VCT's and EIS's.

bowlhead99

jamesd wrote: »

US stock indexes are at quite high levels and it might well be quite a good deal today to by some options to make money from a drop or just to reduce net exposure to the US market. I've been considering buying a bit in a doubly leveraged short US tracker ETF to reduce the net US exposure I have in a global tracker fund. Haven't done it yet, though.

I've been playing around with one of those with some spare money in my SIPP (a DB x-trackers 2x short S&P500). A problem is that while they do quite accurately mirror, negatively and with gearing, an individual day's movement - the results are not always what you intended if you hold them for the longer term. Unlike with options contracts where the gains and losses are a bit more predictable, the performance of a negative geared index ETF very much depends on how it moved along the way rather than where it ended up.

A good example of what I mean, take the SP500 over the last 5 weeks (13 Jan to 14 Feb). The underlying index is down about 4 points (1843 to 1839) which is about 0.2% ignoring dividend yield. However, as you'd see from a chart, it hasn't been flat ; broadly what happened was that the index fell to 2 Feb where it hit 1740, and then after bobbling around there for a couple of days, over the next couple of weeks, it went back up pretty smoothly and consistently the hundred points it had just lost, to virtually recover its start point.

The problem with that 'shape' of the chart will be apparent for anyone who has used shorts for extended periods. For someone holding the double short ETF, the first couple of weeks they are making gains, say the underlying index is down 5% - their investment will be UP more than 5% because of the gearing. In an ideal world where the market fell in a straight line every day with no stuttering noises or bobbling about, the -5% underlying index might translate to a decent ~ +10% for the 2x negative ETF

So lets say you invest £10,000 so that the dealing fees are nominal and can be ignored. Market falls 5%, your product goes up 10%. your £10,000 turns into £11,000 for a 10% paper return. But you don't sell. Then the underlying index recovers from 95 back to 100 which is a +5.25% gain. Your product takes a -10.5% loss.

So, having had £11,000 invested when the market turns (a larger number than you first started out with), you lose 10.5% of it which is £1,155. Leaving you with £9,845. So you made a nice return on your initial investment at the halfway point, but then effectively lost a larger percent of a larger number in the second half.

So, over the month you are more than 1.5% down even though the market is flat.

That concept is what happened to my 2x short ETF: over the last month, market fell 0.2% (excluding dividends) but the ETF is not up 0.4% or flat, it's down 3%. I'm looking at my ETF in sterling not dollars so there will be an FX effect in there too, but overall it's a bit frustrating. Particularly as I wasn't investing as much as £10k, so the nice paper gain % I had along the way after only 2 weeks wasn't a large absolute amount of cash so it wasn't really worth taking off the table, after dealing fees.

Basically, the short ETF behaviour could be very useful for a day trader but not so good for a buy and hold investor who just wants to hedge his US investments. Volatility is not your friend and the overally results seem unpredictable if you're not watching the daily movements to see how they are developing.

By contrast, paying a few hundred quid for an out-of-the-money short option contract is a bit more straightforward because you can get highly geared returns with a known maximum loss and very easy to calculate end results. But actually if you decide not to hold to maturity, the price you can get for selling the contract at a point in time is going to be a function of the market level and direction (easy to measure) and current perceptions of volatility (not so easy).

So in summary - I'd agree US markets are high, but hedging your exposure to them through derivatives can be complex. I prefer options over short ETFs though this is perhaps coloured by my own relative successes rather than fundamentals. Perhaps it is more straightforward to just sell off a portion of each of your US-facing assets in your portfolio to buy back later, but that comes with dealing costs - and obviously, knowing when to go long again is just as tricky a question as when to stop going short.

Given "the market can stay irrational longer than you can stay solvent", you can see why people just hold on tight rather than try to time the market.

jamesd

Yes, there are definitely potential - and actual - tracking error issues with ETFs. I wrote double leveraged because I found that the long FTSE tracker I used for the first part of last year tracked reasonably well at double leverage but not the triply leveraged version.

Short options are definitely a cleaner product so far as that goes, just more unfamiliar for more people.

For a global tracker fund and desire to reduce US weighting without having the costs of things like initial charges the ETF might still be a decent purchase, in spite of the tracking error. But you definitely do need to be aware of the issues with them!

I've yet to personally even buy an options contract. Maybe you'd be kind enough to share some tips and issues based on practical experience with them that I don't have? Perhaps some thoughts on what might be good to hedge US exposure/risk at the moment?

bowlhead99

I guess it's hard to do a complete 'how to' guide for option contracts in a forum post. I'll assume you know the basic gist of what an option is.

The main pitfall with any option, CFD or spreadbet is to understand your potential exposure; if all you are doing is buying a put or call option contract on an individual stock or index, your risk is well controlled because the worst that can happen is that it ends up out-of-the-money and worthless - you know how much you paid for the contract (or if doing it through spreadbet, you know how many pounds a point you bet, which can be easily multiplied out in your head to get a simple maximum exposure).

However if you are trying to back the opposite direction, and sell a call or a put, you can be in a position where you have a maximum gain available but unlimited losses. The gain might be much more likely than the loss, based on your read of the markets at the time, but if the potential loss is uncapped it can get potentially very expensive.

Another thing to watch out for is the expiry date and time of the contract. If you are hoping S&P will finish at 1700 or less by the end of the week and it's currently at 1702, the option is out of the money but has a decent value, because people would like to be in that position of making profits when the market goes down with limited risk. But as the expiry time gets closer and the gamechanging market news for the week is already out (e.g. interest rate meeting on a Wednesday and employment stats on the Thursday), your Friday-expiring option gets less and less valuable as there is limited likelihood of making a decent profit... and then all of a sudden the expiry happens and if market is 1700 or higher and your contract or bet suddenly becomes worth zero pence, even if every man and his dog are still expecting the market to drop like a stone the following week.

Also there are different methods to take options on shares or indexes. The spread-bet version of the options will always settle in cash, i.e. simply paying you out the difference between the market and your option level at maturity, as if you just 'won' a bet. However with some contracts if you still hold them at maturity, they will auto-execute if you are in the money, and literally make you take the option of buying (or selling) the index or share for that price.

So for example a few years ago I had a call option contract on a US share with a strike price of, say, $20 at a certain point of the month. My option position, bought quite cheaply when out of the money, was for something like 300 shares. So if the share finished at $22 I would be up $2 x 300 shares = $600 and if it finished at $23 I would be up $3 x 300 shares = $900. I had previously held the options over 500 or 600 shares, but already sold some and banked the cash earlier in the month. In my naivety I presumed that when the market closed on Friday at $23 I would get my $900 profit like I could have taken on Thursday and like I would get with a cash-settling spreadbet option which I had used many times before.

However what actually happened was that the option executed at my strike price and I was now holding 300 shares for which I owed my broker $6000; albeit they were worth $6900 on the market at Friday's price. Fortunately I noticed on the Monday that I still had this (relatively) huge exposure and a liability to pay for the shares on settlement day. I dumped them ASAP with no harm done (actual profit a bit over $1k as the rally continued into Monday), but I had a lesson ringing in my ears about reading the small print.

If you are just looking to hedge general US exposure within your global portfolio and are able to do it with cash outside an ISA or SIPP (rather than doing it from within one of those wrappers) the easiest thing to use is a spreadbet. Not even an option, just a simple 'short' bet, with as much or as little gearing as you want based on how many pounds a point you want to 'play' for. At maturity (or any point before) you can cash out and take profits based on how many points the index has fallen. Any gains or losses are tax free. Of course if the market goes strongly the other way it can be very costly, although you can use a 'controlled risk' or 'guaranteed stop' feature to ensure you are stopped out if the underlying market puts on a certain level of gains. Guarantees will cost more in spread (i.e. the market maker's fee) though, and it might be annoying to be stopped out on a short term spike and then be out of the game when the market crashes back down the following week.

So an option on an index from the same spreadbet firm that you just buy and forget, could be more useful - your loss is limited and no danger of getting stopped out if the price is volatile. You just virtually buy a put option on a particular strike level with whatever maturity you want. For example SP500 at 1700 or 1800 or 1900 at end of March 2014. 1700 would be pretty cheap (as it's something like 7.5% below the current market) and hence you could afford to front the money for a large return per point of index drop, but it only returns a profit if the index drops significantly - if the market merely fell 5% you would lose your stake (your stake is effectively the option premium if you were buying for real rather than virtually through a bet).

Buying a put option with a strike price of 1900 would be more expensive because it is already in the money and so for the same amount of cash down you would only be able to afford a very much smaller position. But the advantages of using an in-the-money option over simply going short on the index is that you know how much you can lose (without risk of your bet stopping out and terminating if the market had a strong rally)

A few of the firms providing options on indexes through CFD or spreadbets publish little 'strategy guides' to illustrate what you can achieve with combinations of options - collars, straddles etc which may allow you to limit exposure or maximise profits if you think the market is likely or unlikely to strongly move one way or the other because there is some news coming, but you don't know which direction it will actually go. If you just want a general opportunity to profit from a falling market, such things are probably a step too far but there is lots of information out there. Probably moreso on independent sites or in books than from the providers themselves

http://www.iii.co.uk/futures-options/new-to
http://www.cityindex.co.uk/range-of-markets/options-spread-betting.aspx
http://www.ig.com/uk/trading-psychology

2010

http://www.dailymail.co.uk/money/diyinvesting/article-2559424/The-investors-think-dodging-bullets-better-buy-hold.html