Smart Plays In Volatile Times
If you have a strong stomach and like a good gamble, the current volatility may be a good opportunity to put some money in play to beef up your portfolio gains before the end of the year.
While the pickings may seem slim, investment strategists say there are some opportunities within certain sectors, and if you are considering making broader bets, using options strategies can provide a good way to maximize gains while limiting losses.
“We have no leadership in the market in terms of industries,” so choosing sectors to invest in is a challenge, says Charles Rotblut, senior market analyst with Zacks Investment research.
“Investors should rely heavily on technical analysis,” adds Rothblut, while also paying close attention to fundamentals such as valuations and upwardly revised earnings estimates.
Rotblut suggests looking for some potential winners in the retail sector.
There are various securities in this group that have been able to maintain a good trend upwards and continue to see a steady flow of customers. One company in particular that he likes is video game retailer GameStop, which has been able to continually attract customers and could benefit further as the holidays approach.
Rotblut said there also might be some individual opportunities in the oil services, healthcare and consumer staples sectors. While he recommends investors avoid the heavily trampled financial sector until it is clear that the sector has hit its bottom, some investors may find some opportunities there.
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Todd Salamone, an analyst with Schaeffer's Investment Research said he sees opportunities with certain banking stocks such as PNC Financial Services and Wells Fargo. Both of these companies have shown strong price action throughout the current financial crisis. Wells Fargo shares have almost douvled from their Juy low and are now higher than they were before the Lehman Brohers chapter 11 filing and the AIG rescue package. PNC's stock price recently an all time high.
In addition to looking for winners, investors should also consider making bearish bets on stocks that have deteriorating prices and fundamentals.
Betting against a security can be done by shorting stocks—borrowing and then selling shares on the bet that the price will fall and you can repurchase the shares at a cheaper price. (Of course, the pool of contenders was reduced by the government's decision to bar the practice on some 800 financial stocks.)
You can also purchase an inverse exchange traded fund that delivers returns that are opposite those of a given index or using options strategies.
The latter is a strategy that many experts agree investors should employ regardless of whether they have a bullish or bearish outlook on a particular security, sector or the broad market.
“The key to this market is using options, where the most you can loose is what you put up but you can generate returns in excess of 100%,” says Schaeffer's Salamone. “Using options is superior to [a long-short strategy] because with options you can benefit from volatility.”
Let’s say, for example, you wanted to bet on small caps outperforming large caps, as many anticipate will happen. In this case, you could buy calls—which give you the right to buy a fixed amount of the securities at a specified price within a certain period of time—on a small cap ETF, such as the iShares Russell 2000 ETF (IWM). You could then buy puts—which give you the right to sell a fixed amount of the securities at a specified price within a certain period of time—on a large cap ETF such as the Dow Diamonds (DIA) or the Spider Trust .
“This would essentially be a way to make a relative strength bet. If the market were to collapse you could get returns of 100% on the Spider or Diamond puts and on the iShares Russell 2000 ETF call you could still reap a profit,” Salamone said.
Randy Frederick, director of derivatives at the Schwab Center for Financial Research said you can also use options to make bullish and bearish bets on the direction on the broad market.
If you are like many investors and expect the market will continue to get worse, Frederick suggests doing a credit call spread order – this entails buying one call option and selling one call option, where the option that you sell is more expensive so you essentially get a credit.
For example, say you wanted to take a bearish position on the PowerShares QQQ Trust,which tracks the Nasdaq 100 Index, which is trading around $41. You could sell a $35 call option and buy a $40 call option that expires in October.
To break even, Frederick says “all you need is two points of downside movement to break even, and beyond that you’re profitable.”
“A six point drop in the Qs is feasible if you’re extremely bearish," he adds. "That would be about a 10% profit in about a month and you only have about $100 per spread at risk.”
Frederick warns that this strategy is not for the faint of heart. Nor is actively playing the market during such volatile times, however, if you take the time to choose the right securities and employ a good strategy, the current market may be as exciting as it is frightening these days.