Short Term Protection for My 2020 Outlook

Many of you know we believe we achieve superior rates of return by following the smart money. Our thesis is that firms with far more capital can afford more in-house analysts, generate more commissions and thus can leverage all three into procuring information about publicly traded companies. That information needn’t be insider information, although doubtless some unscrupulous firms do play that dangerous game. We believe the bulk of the unusual activity we track in stocks, options, futures and crypto are investments placed because the firms have moved the odds significantly to their favor. And when one manages hundreds of millions of dollars, in some cases billions of dollars, the trades are quite large. Those are indeed the smart money trades we seek to follow.

However, we need to always be aware of which catalysts might be part of the investment landscape. I have detailed both the Consumer Electronics Show (CES) and JP Morgan Healthcare conferences as two such catalysts in early 2020. But there is another that many of you are aware of and in some cases fear; profit taking.

We haven’t seen much profit taking in December, as most of the holders prefer not to sell and thus incur a tax liability when they can just wait until the calendar turns and then take their profits. I’ve seen this play out far too many times to list here, but suffice it to say that if this profit taking occurs when the calendar flips, there could be a bit of a whoosh downward in early 2020.

My outlook for the markets has not changed. I am still anticipating a double digit return from the major indicies in 2020. Nevertheless, I would be remiss if I didn’t call your attention to the delayed profit taking that I believe could occur in early 2020. For that reason I have asked our co-head of trading to offer an example (not a recommendation) of how an investor might mitigate the impact of a potential 5% selloff. Here he expresses a protective trade that would help offset $100,000 of investor’s holdings. Thus, if you had a million dollars of long exposure in stocks, this example would be applied ten times.

To express that short-term bearish protection I’d buy 3 SPY January 17th expiry 319 puts for $1.97 and sell 3 SPY January 17th expiry 314 puts for $1.22. That’s a $.75 debit for a $5 put vertical spread.

As each option is for 100 shares, each spread we purchase costs us $75. As this example is to hedge a $100,000 long portfolio, those three puts will cost us $225.

If you had a $500,000 long portfolio, 15 spreads. If you had a $1,000,000 long portfolio, 30 spreads.

In closing, I’d remind you that on December 3rd the SPY was trading $309.55.