It seems like the perfect storm of market uncertainty is upon us. With a US election that has global impacts just a few days out, a pandemic still in full swing and millions of people out of work, there is bound to be volatility in the markets. If we maintain a cool head, we may be able to trade this volatility to our advantage. Here are 5 different ways you can play the market uncertainty to your benefit.
In times of fear there are numerous strategies that people employ to hedge against equities. Some of the classic examples include gold and cash. If we take a look at $GLD since the beginning of this year, it is up almost 20%. There are a significant number of people who use gold as a safe store of value during times of uncertainty. Gold is also an inflation hedge, since there have been multiple stimulus packages helping the economy, people turn to gold when they believe the dollar is weakening. As the Fed continues to do their best to avoid a complete economic meltdown, gold can be a play during this time of uncertainty.
Another option that has been increasing in favor recently is cryptocurrencies. There are many to choose from but some of the most popular are Bitcoin, Ethereum and Tether. Tether is an interesting double hedge since it is directly back by the US dollar in a reserve account based upon the supply currently outstanding. If we look at Bitcoin since the beginning of the year, it is almost up 50%. This is partially due to people hedging during uncertainty as well as the speculative nature in the cryptocurrency markets currently. Either way, if you are looking for a hedge to holding equities, these are just a few of your choices.
There are a couple different ways to play market uncertainty with options. One of the most common ways to hedge a long position is by buying a put. For example, if we are long on $T with a cost basis of $30 we may want to hedge our position as $T is currently trading around $27.25. Let’s say we don’t want to lose more than $7 per share or more than 24%. Using puts, we could pay $2.15 to protect our position until September 17th next year at $25 a share. This gives us downside protection below $25 per share for only $2.15 a share. We still have the ability to take advantage of any upwards movement while being protected on the downside if $T continues to slide.
Another way to trade uncertainty with options is using a straddle. A straddle takes advantage of any price movement whether the underlying is increasing or decreasing in price. This is done by buying both a call and put for the same expiration and same strike price. The downside of this strategy is that it requires significant price movements in order to be profitable. Small price movements or the underlying trading flat will cause you to lose money on this trade. This can be particularly useful right now around earnings reports since many companies are posting dramatic beats or losses. If you are looking for other strategies that are useful in high volatility environments, check out the wheel strategy.
VIX is an index that was created by the Chicago Board Options Exchange to track volatility in the market. The Index VIX is often referred to as the ‘fear index’ because it tracks overall market sentiment. As you can imagine, this can be particularly helpful to those who are looking to profit from uncertainty in the markets. VIX is an index and is not traded directly but there are Exchange Traded Notes(ETNs) such as VXX which does track VIX to make trades. These are meant to be short-term directional based trades, not a set and forget strategy.
Another way to use VIX is as an indicator. As VIX climbs, that means there will be more implied volatility in options. As VIX decreases, implied volatility will also be decreasing. Increasing volatility results in higher priced options and decreasing volatility reduces the cost of option contracts. This is of course assuming all other things are equal. Now whether or not you want the price of a contract to increase or decrease depends on your individual play. If you are long, you may want your contract to appreciate so you can sell it for more than you originally paid. If you are short, you may want the price to reduce so you can close your position and move onto your next play.
Dollar Cost Average
The best investing timeline ends a long time from now. If you have an investment timeframe that is decades out, the best thing you can do during market uncertainty is just staying the course. For Example, if you were buying every 2 weeks, keep buying every 2 weeks. If you have a portfolio balance you are trying to achieve, check back every quarter and rebalance when appropriate. Most people think they are timing the market and end up moving into cash during a rally and buying during a pullback.
This is one of the hardest strategies to actively do since there is so much information being thrown at you every day. The best thing to do is to automate the whole process to keep decision making out of it. The best time to start investing was a century ago, the second best time is today. So just keep investing your money in broad market ETFs and reap the rewards in 30+ years.
Perhaps the most difficult way to trade uncertainty on this list is momentum trading. This methodology involves identifying movement through technical analysis and following the trend line with your own trades. The most difficult part of these trades are the exit points, because it can be hard to identify reversals while looking backwards.
These trades involve studying underlying security’s charts on a regular basis to gain intimate knowledge of their behavior. Most momentum traders only trade a basket of securities so they can constantly watch the charts. It also involves knowledge of technical indicator and what they tend to mean. For a quick primer on technical indicators, check out this post by Harry Nicholls. This is also a very hands-on trading strategy which means human error will play a more significant role than some of the other methods mentioned above.
Winning During Market Uncertainty
There are dozens of strategies that will work when volatility is high. These are just 5 of my favorite strategies that I have personally used to take advantage of movement in the markets. It is important to identify how active you want to be in your portfolio and how much risk you are willing to accept. When you combine these two thoughts, you can properly pick a strategy to help you maintain profitability during times of uncertainty.
Have you used any of these strategies? Comment below with how they worked for you!