The markets have recovered from the lows they experienced in the last month, and even managed to finish up for the month of August. However, I remain very cautious on the overall state of the market. I along with plethora of others think that the collapse of the housing bubble will have serious repercussions for the economy. Will the U.S. recover in good time? I have complete faith that it will. However in the near term (1-2 years) there are major risks and uncertainties.

So what is one to do? I’m certainly not an advocate of selling everything ahead of a collapse that may not happen. I was already worried about the market even before the credit crunch of July/August, and what seems like a continuous litany of bad news from the housing market. My worries were reflected in a relatively large cash position, but I hadn’t done much else to protect the rest of the portfolio. As the market bounces around, I’m slowly deploying a few strategies to better protect my portfolio on the bounce ups.

  • Selling Losers with diminished near term prospects
    I’ve sold a portion of my holding in Washington Mutual (WM) given the company’s exposure to the Morgage Business
  • Buying put options on appreciated stock
    I’ve purchased puts on company stock that I own
  • Selling call options
    I’ve sold calls on EWZ (iShare Brazil ETF), and Intel (INTC)
  • Buying put on the indexes
    I’ve purchased puts on the Nasdaq 100 (QQQQ)

The put options I brought offer real protection against a market downturn, and I have tended to buy put options that are at least a year out if not longer. Selling calls does not offer me the same kind of protection. By selling a calls, I’m merely earning a relatively small premium. The calls I’ve sold are shorter duration with expirations in 6-9 month range. Because the market has been as volatile as it is, the price of options have gone up. The price of an option is directly related to the volatility and length of the option. Selling calls because of the recent volatility has been attractive even on stocks that are traditionally not that volatile such as INTC. For example I was able to sell options on INTC with a April Expiry, for 1.95 at strike price of 27.5 while the the stock at the time traded right around $26 representing a 7.5% premium or nearly 10% annualized.

While I’m more of an advocate of market timing, and individual stock selection than many other personal finance bloggers, I’m not that much of an advocate. Too frequent action on the part of individual investors who usually don’t have the time even if they have the skill can be the downfall for most portfolios. I think most investors are still better served by sensible asset allocation and periodic rebalancing. I haven’t touched my 401k since I rebalanced earlier in the year. The protective moves I’ve implemented represent less than 20% my entire portfolio, and are hardly taking me out of the market. I’ve paid a premium for the put options, and the calls I’ve sold are slightly out of the money. What I’ve done is to trade some upside for some protection if the market turns south. Given current state of economic affairs, I’m willing to do that.