While expert investors utilize put options and short selling to make money in the markets, the average individual investor mistakenly attempts to time the market.
“Soros doubles a bearish bet on the S&P 500, to the tune of $1.3 billion.”
The above headline from Market Watch, an online subsidiary of The Wall Street Journal, suggests several possibilities: either George Soros thinks the market is overvalued and is betting against it, or he is simply hedging his bets on his own enormous portfolio in the event the market does drop.
It is true the stock market has been on a tear for 29 months. This, in itself, can make investors feel uneasy. Since it always reverts to the mean, obviously there will be a correction—of course, when and how much is anyone’s guess.
Soros is addressing this threat by purchasing a “put” option on the S&P. If the S&P goes down significantly, Soros can profit by selling the option at a gain or exercise the option to buy the underlying market at a specific price before the expiration date.
Purchasing a put as Soros did is one way to protect against the market is going down. Short selling, buying a borrowed stock at the present price and selling at a lower price if/when it does swoon, is another. Of course, if the stock doesn’t drop in value, there will be a cost.
Purchasing a put and placing a short sale are techniques normally executed by expert traders and are considerably more risky for the average investor, who is likely either to be unfamiliar with the tools they require or to have the market data needed for adequate analysis.
Nevertheless, some individual investors attempt a similar maneuver by selling some or all of their portfolios when they think the market could go down (i.e. market timing). Sadly, for these individuals, this approach is most often fraught with pain because historically the strategy doesn’t work.
Taking money out of the market means missing big winning days. Since 1994, this is what lost market days would have gleaned an investor who chose this strategy.
Jan. 1, 1994, to Dec. 31, 2013, S&P Annualized Return
Return from all trading days: 9.22%
Minus 5 biggest: 7%
Minus 10 biggest: 5.49%
Minus 20 biggest: 3.02%
Minus 40 biggest: -1.03%
Data from Index Fund Advisors
Although market timing is almost certainly a fool’s game, let me add one circumstance in which I believe a form of it may have value in specific circumstances: disaster investing. Through this style of investing you would buy a blue chip stock or index when the market unexpectedly takes a fall due to news that the public interprets as not only serious, but scary.*
In a previous column, I chronicled my own foray into this area which did not end well. What I didn’t say is that it has worked for me at other times when the market did not drop to the level it did in 2008-2009 (roughly 40%, ultimately). During the other times, I held my position.
One example is 9/11, when the market not only tanked, but closed. Americans were uncertain and that brings fear. As is apparent from the chart below, however, it was just a blip in our recent market history. These circumstances are times when Americans have an opportunity to make money. After all, they are the ultimate “buy low,” and later, hopefully, “sell high.”
S&P Chart from Yahoo.com. The remarkable drop in the stock market on 9/11 is historically only a small dip S&P history.
* This is not really market timing per se but simply taking advantage of a market that has already submarined itself.