We couldn't keep the profit-takers at bay

by Wayne Ferbert on June 4th, 2012

If you remember, we wrote two articles in late April & early May about the three things that had to happen to keep the profit-takers from driving the market lower. Well, the jury has deliberated: the profit takers won!

The market swoon in May has been terrible. We are back to the level we started the year at in the S&P500 & the Dow Jones Industrial Average. It is officially tough times in the global markets.

If you remember, we said that three things had to happen to keep the profit-takers at bay:

1. Earnings season had to be a complete success – NO EXCUSES! Must be an unmitigated success.
2. Economic indicators must be solid – not spectacular just solid. We could even get away with mixed results if the most important results were good.
3. European news must quiet down – and they must avoid really bad news. Bad news is ok. Just not really bad news.

We lost on two of these three counts. The earnings season was a success. Corporations posted good earnings and held up their end of the bargain. The problem was the economy and Europe.

The jobs number on Friday was an un-mitigated disaster. It is one of the key indicators and it was terrible. There are few other economic indicators that could overcome that bad news – maybe a GREAT GDP number or a big revision upwards next month. Neither is likely.

But Europe reared its head in a somewhat unexpected way. Spain and Portugal are looking for bailouts now also. Greece will not accept austerity. Germany is trying to make everyone blink before they do. It went from very bad to very very bad.

The result: the profit-takers decided to take risk off the table. Volatility is now up and the cost to buy downside put protection is on the rise.

Our recommendation: put money to work by selling out of the money puts on broad market ETFs – like SPY & QQQ. Force yourself to buy in to this market as it goes lower – but only with the put that has a strike even lower than the market today. This way, you are buying at even a lower price.

But one change we might advise: don’t wait to buy your hedged protection when you get exercised (if you get exercised). Buy half of it now in a far month (like January 2013). That way, you have already begun to leg in to your laddered protection – and you are protected at even higher levels in the event the market really tanks.

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