Investors A Recession Away from Total Destruction
$FB, $SQ, $MSFT, $ABX
TheBig Q’s: Would you like to:
- Make a bit of money most of the time, with a small chance of losing a lot?
- Lose a bit of money most of the time, with a small chance of making a lot?
The Big A: Most people would choose Door #1.
Most investors do not buy options because most options expire worthless, and one has to be a savvy player to win in that space.
So, let us say 90% of the time, you lose, and 9% of the time, you break even, but 1% of the time, you win big.
Most people do not have the mental ‘Make Up’ to lose at something 99X out of 100. But, that is what VC (venture capital) is about.
You invest in this portfolio of companies, and the vast majority of them go nowhere, but maybe 1 turns into Facebook (NASDAQ:FB) or Square (NYSE:SQ). My early big plays were Microsoft (NASDAQ:MSFT) and Barrick Resources (Gold) (NYSE:ABX).
But more people would rather sell options against positions, than buy options.
Why, because there is a limited gain and unlimited loss, as 90% of the time, you make a little bit. 9% of the time, you break even. 1% of the time, you get hammered.
People like positive reinforcement, so selling options that expire out of the money they figure the 1 in 100 happening will not happen to them.
Which strategy is right?
That depends on the strike price of the option.
Sometimes options are cheap, and sometimes they are very expensive. Right now, options are very cheap. Savvy players buy them instead of selling them.
But in true market fashion, today everyone is driving to sell them. And when the market is in crash mode, and the prices of options are all up, and everyone wants to buy them.
That is human nature, unless you are a seasoned, disciplined participant in options space.
Professional traders know every risk decision can be boiled down to this: either you are risking a lot to make a little or risking a little to make a lot.
Bonds have embedded options,
Example: if you own a bond, like some Home Depot (NYSE:HD) bond at 4% you are ‘clipping’ small coupons aka making a little. And if something goes wrong and in the unlikely event that Home Depot defaults, you lose everything. It is very much like selling options.
Savvy bond investors understand this asymmetry.
But not every bond works this way. Buying distressed debt is very much like buying options. If you are buying a defaulted piece of paper trading for 15%, read $0.15 on $1.00, chances are, you are not going to get very much in bankruptcy court, read lose a little, but who knows, maybe you score big in the restructuring and get some stock that spikes.
I have never bought a bond except US Saving Bonds which I gave a gifts to children. My bias is net Long volatility.
Now this easy money scenario which has been on since QE-1 is getting dicey.
You may have learned that about 50% of all government bonds globally are now trading at a Negative yield, that means Zero Minus
This is what is happening
The world’s leading central banks’ (US Fed, ECB, BOE, BOJ, PBOC)) Zero interest rate policy has made it really hard for savers, retirees, pension funds and individuals to earn any income at all. They are being squeezed by this policy, year after year after year.
I recall when I used to make 6% in cash on my deposits, that has been squeezed out the risk curve, into government bonds, then corporate credit, then high yield, and now into dividend-paying stocks. And the yields go lower, and lower, and lower. How low can you go, Limbo?
If you are long government bonds that yield less than 1% or negative, you are massively short optionality. You are making a little or nothing, or less than little or nothing, with unlimited Southside risk.
That means, the world of money is absolutely short volatility.
The people here who really know how options work, those of us who understand the concept of “gamma” know what this could potentially mean for risk assets e.g. stocks and bonds.
This scenario will crash dive on one these find days, likely when most all are asleep, like on my birthday in October 1987. And when it does it will absolutely destroy millions of investors who have spent the years since 9 March 2009 chasing smaller and smaller yields.
The Biggest of the Big Q’s: How to avoid it?
The Biggest A: Invest (buy) things that have low or no yield.
- Gold, Silver read hard assets, I like Classic and Vintage Ferraris
- Small cap stocks
- Growth stocks
- Commodities in general
- Distressed debt
- Zero Coupon convertibles
Those are the only places to be as an individual portfolio participant to avoid total destruction in this market.
I am a pattern recognition analyst, and see a rounded top in here, but I and no one else knows when this market will implode and it will, so caution and dry powder are prudent in here.
That recession (correction -10%, -22%, -38% or -55%) is overdue.
Savvy money has been going to the sidelines since last October, that to avoid destruction.
Remember, always take what the market gives, and there will always be a trade.
Have a terrific Labor Day Weekend