New shekel notes 370.
(photo credit: Courtesy Bank of Israel)
Syria is using chemical weapons against civilians. Will the US attack or not?
How far are the Russians prepared to go to defend Syrian strongman Assad? Will
Israel get pulled into the conflict? Will the Federal Reserve start to “taper,”
thus beginning the end of record-low interest rates? Throw into the mix
emerging-market stocks and bonds getting slaughtered. Did I get your spirits up?
Well REM may “feel fine” with the end of the world, but investors are skittish.
Even I, in general an uber-optimist, must admit that things aren’t quite so
rosy. My phone hasn’t stopped ringing from nervous investors who believe recent
events are some kind of foreshadowing of Armageddon.
As such, these
clients want to know how they can potentially profit from
While there are many different solutions to this question,
I would like to focus on three approaches to both protect your capital and even
profit from a stock-market drop.Volatility
Many professional investors
like to look at market volatility as an indicator of future stock-market
performance. The VIX Chicago Board Options Exchange (CBOE) Volatility Index,
shows the market’s expectation of 30-day volatility.
The VIX is a widely
used measure of market risk and is often referred to as the “investor fear
Saiers Capital hedge-fund manager Nelson Saiers told Reuters: “If
you buy crash protection, you most likely lose a small amount of money, but if
there is a crash, you make a windfall.” As volatility measures dropped over 30
percent in the first half of the year, a continued tick up in investor fear
could potentially send these products much higher.
According to Edward
Szado, a research analyst for the Center for International Securities and
Derivatives Markets at the University of Massachusetts: “Investable VIX products
could have been used to provide some much-needed diversification during the
crisis of 2008... The performance of markets in recent years suggests that VIX
may spike upwards as the S&P 500 experiences large drops, leading one to
believe that a long VIX position could provide significant diversification
benefits to an equity portfolio.”
There are a few new products structured
to capitalize on movements in the VIX. Keep in mind that investing in volatility
is very new for most investors and comes with risks. Investors need to take the
time to understand how these products work.
The classic way to
cushion your portfolio against a market drop is by buying “insurance.” Buying
put options as an insurance policy on your portfolio is like having home-owners
insurance to protect your house against a fire. A “put” is an option contract
giving the owner the right, but not the obligation, to sell a specified amount
of an underlying security at a specified price within a specified time. A “put”
option is basically a bet that the market will drop. If it does, the investor
makes money; if wrong, the initial investment in the put is lost.Cash is
I am not the biggest believer in market timing, and trying to accurately
predict a big fall is not the easiest thing in the world. As such, while the two
above-mentioned methods to try and make money on a market drop may work for
some, I tell most of my clients that if they are worried about a market fall,
they should sell some stock and move into cash.
The worst-case scenario
would be that they are wrong and the market continues moving higher, in which
case they wouldn’t participate in the upside. On the other hand, if the market
does go down, they retain the value of their portfolio, and when the point comes
that stocks are at an attractive valuation, they can move back into the
Speak with your financial adviser to see if these approaches fit
your risk profile and whether they have a place in your portfolio.
information contained in this article reflects the opinion of the author and not
necessarily the opinion of Portfolio Resources Group, Inc. or its
[email protected] Aaron Katsman is a licensed
financial adviser in Israel and the United States who helps people with US
investment accounts. He is the author of the book
Retirement GPS: How to
Navigate Your Way to A Secure Financial Future with Global Investing.