LITTLE LEAGUE and STOCK OPTIONS
My athletic career was very brief in that it was limited to my early years in Little League. Our coach had one practice exercise where we all sent to the outfield and required to catch fly balls that he would hit to us. If you caught the fly ball hit to you then you were labeled a “hero” and if you failed to catch it you were labeled a “slob”.
The baseball catching exercise described above also captures the bi-modal outcome of purchasing put options to hedge a stock portfolio. In the last few days, I hedged some of my risk averse clients’ equity exposure. I did not do this without considerable soul searching and analysis. This is because options have a finite life and if the scenario that you envision does not materialize then the options expire worthless and the premium that you spent to protect the equity portfolio is forfeited. My rationale for purchasing the put options on the SPY exchange traded fund is as follows:
- The debt limit debate appears to have the potential to damage our credit rating as well as our standing in the world community. This could engender a rapid increase in interest rates and a severe decline in the US dollar.
- The effects of the Fed’s rapid increase in rates are only just beginning to be felt since there is a significant lag between the rate increase and the real world impact. A credit crunch may be imminent.
- Regional banks, especially, will demand much higher credit quality on the loans that they do make and will cut back on the quantity of loans significantly.
- Commercial real estate (think empty office buildings) is potentially a ticking time bomb with a large amount of maturities over the next 6 to 18 months. Their low rate debt will be rolled over to much higher rates or will produce a surge in defaults.
- Consumer credit defaults (auto loans and credit cards) are beginning to ramp up; repo men and bankruptcy lawyers are very excited.
- The stock market is not cheap.
The above list is not exhaustive and does not even contemplate any number of geopolitical events that could also have a negative impact on portfolio values. Of course, clients’ risk tolerance enters into the equation in a big way. Generally, a longer time horizon and/or significant assets along with a client’s personal feelings about risk play into the decision as well.
I promise to get back to you in early Fall to let you know whether I am a hero or slob as far as the option purchases are concerned.
ENDNOTES
Disclosures
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her advisors.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
A word on risk
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non-U.S. investments involve risks such as currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. This report should not be regarded by the recipients as a substitute for the exercise of their own judgment. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.