Other investor's excuse to sell is your opportunity

by Wayne Ferbert on April 5th, 2012

Between last week and this week, the market seems to be trading a lot on the news from Europe. In particular, the weak Spanish bond auction this week has spooked a lot of investors and made some re-evaluate the risk-on trade.

Let’s face it: with the great market run, many investment strategists have been looking for a reason to take some money off the table. Every strategist wants to successfully call the top on the market – almost as bad as they want to call the bottom.

But the Spanish debt story is just an excuse to sell. The story has been: Spanish debt sells at yield higher than expected. Risk in Spain must be worse than expected. Is it really? Were expectations really for lower debt rates in Spain? Among savvy investors, I don’t think it was.

Didn’t we all know that further erosion in Europe was around the corner? The European debt crisis was just getting its legs under it last Summer. Just because our market rallied doesn’t mean the European problems went away. The debt to GDP ratios in Europe are abysmal – and have been for a long time. A continuing European problem has been priced in, I believe, from the word go.

The debt problems are going to weigh on them for a while. After all, the obligations to pensions and retirees are significant and likely to create a drag on a recovery there for a long time – it could be a decade.

While Europe will always matter to US investors, I don’t believe that Europe can stop the recovery occurring here in the US. While that continent is an important trading partner with us, it’s not as important as it once was. It might slow our recovery – but it will feel like a bump in the road – not a detour.

So my conclusion, the recent European news is just an excuse by institutional money managers to take some profit off the table. We just finished the best first quarter for the S&P 500 in decades. Profit taking does make some sense – for anyone that has a need for the cash … Or for an institutional money manager that wants to protect some nice gains.

However, if you don’t have a need for cash, we believe the market still trades at a discount. So, an idea for you to consider: find the stocks or ETFs that you have been thinking about owning – and look to take advantage if this sell off continues. You could get in at an even lower price.

An options technique we like to use to get in to the position at an even lower price: sell a slightly out-of-the-money put option. If you sell a slightly out-of-the-Money put in a near-month, you will collect premium and will get triggered in to owning the stock at the lower strike price if the market keeps going down. Your basis for owning the stock becomes the strike price minus the premium you got paid. And if you don’t get executed in to the stock, you collected the premium and it is all profit.

One other thing to consider: maybe think about buying an even deeper OTM put for an expiration about 6 months out. This will protect you in case you do get executed in to owning the stock and the stock falls deeper because the market falls more. Rule #1 of Buy and Hedge is Hedge Every Investment. By owning the put, you have your protection. And you will have bought your protection at a lower price than the case where you get assigned to buy the stock.


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