By Laurie Itkin
Learn more about Laurie on NerdWallet’s Ask an Advisor
Tuesday, May 28 was the 20th Tuesday in a row that the Dow Jones Industrial Average finished higher. I can find no time during the past 100 years that this has happened before. Even with the recent volatility of alternating ups and downs in early June, both the Dow and S&P 500 are up about 15% since the beginning of the year…what a run up! If you have had cash sitting on the sidelines, you’ve missed a great bull run. Should you get into the market now? And what if you are fully invested in the market? Should you be getting out? There are no easy decisions when it comes to investing…it depends on your time frame and risk tolerance, among other factors.
If you have made significant gains in your portfolio, what is your plan (or your adviser’s plan) for protecting those gains and minimizing any downside loss? Bull markets don’t last forever. Stock markets regularly “correct” (generally defined as a fall of about 10%) as they are a normal course of the cycle. The next correction might be intensified, since the Federal Reserve Board has been using powerful monetary policy to get us out of the recent recession. When the music stops playing (i.e., when the Fed decides to put the brakes on QE), the market will respond. We got a brief taste of that in May when traders got wind that QE could soon be reaching the end of its lifespan.
There are a number of ways investors can prepare for the next downturn by hedging their long positions. The first way is one we all know about: sell some of your stock holdings and take those profits off the table. You could also “short” stock or purchase an inverse ETF but those strategies require lots of time and maintenance, not to mention a steel stomach. The alternative I prefer is selling call options on stock, buying put options, or creating a “collar” by doing both. At Coastwise Capital Group, we specialize in using conservative options strategies to reduce risk in a portfolio. One of our core strategies is using “covered calls” which is a combination of 100 shares of stock or exchange traded fund (ETF) and the sale of one call option. This strategy generates income tied to stock holdings which provides some downside protection (or a “hedge”) should the market go down.