Would I Consider Buying Puts?

Patrick in my blog entry on the bubble asked:

At times like this would you consider writing puts on stocks you might want to pick up should they retrace 25-50% of the rally?

Quick answer: No…

Why? Because it costs too much. In addition to my contrarian investment strategy I sell premium. And what I have seen is that in the past four to five months there have been plenty of people buying puts and seeing them evaporate with a zero value. If you do this time after time after time you loose your gains.

Let’s say that you have a 100 shares of the SPY. And because we all have been predicting the fall of the SPY I could have bought PUTS for 2 USD approximately per share.

Now doing the math this will be the sixth up month and thus you have just paid 12 USD per share for nothing. 12 USD is 12%, and to break even you will need the market to break below 12%. Considering that most corrections are in the order of 10% you would be loosing 2%.

Let’s flip the math around, and let’s say that I sold my shares now, which would be 111 USD approximately. That means I can wait until the S&P will hit 123 USD before I loose money since my insurance would have cost 12 USD.

Simply put whatever way I slice it, it gets expensive for a potential event that as of yet has not occurred.

Instead what I do is buy on the way down, and sell on the way up. Yes I catch falling knifes and leave money on the table. But that is ok for me. My strategy for the most part is a risk management approach to investing. This means I always keep enough money and margin available so that I can move out of and into other positions.

Throughout my short career (5 years) in the market I have learned that people go bust because they run out of money. I am a student of financial history and most times the strategy was right, but the liquidity ended and thus they went under.

Hence I have learned that my main focus should not be strategy, but being able to out-last the market to fully execute my strategy.

As John Keynes said:

The market can stay irrational longer than you can stay solvent

Don’t ever forget that!!!!

PS: Whenever I sell and see a stock like Apple go up I keep telling myself: “You made 90%, and did this twice so forget it and move on.” The worst thing you can do is question your judgement. Focus on the 90% you made!!! BTW in the five years I have been in the market I have made 252%. Thus if five years ago you had 100 USD you would have 252 USD now and that is going long only. I don’t short!