Get an umbrella! Or at least buy yourself some dirt-cheap portfolio protection!
The gist is pretty intuitive: Stocks have had a ridiculously surprising run over the last two years, and the headwinds are huge.
- Oil is surging.
- Other input prices are surging.
- The dollar is going to garbage.
- Unemployment is structural and will stay high
- The housing market still sucks.
Plus, there’s the fact that the training wheels are coming off, as we’ve been writing about all morning.
So what to do given that shorting is killing so many people?
My advice is to buy insurance (or volatility) — it’s cheap, more attractive on a risk/reward basis, less frustrating than shorting “the market” and, if timed well, provides huge upside. As an acquaintance in Europe said to me, shorting equities is like a “leaky water pistol,” and employing the increasingly popular VIX tactic that follows is like detonating “two sticks of dynamite” in a dynamite factory.
It goes like this:
- Find the sweet spot of the curve, which is usually eight to 15 weeks out to expiration, where “roll yield does not eat into your returns and you can still see an explosive upside to your investment.”
- Sell an out-of-the-money call option on the VIX.
- Use the call premium (in step No. 2), and buy two calls that are further out-of-the-money.
- At the time, the three options are out of the “sweet spot” — take them all off and put the options back on that reside back in the “sweet spot.”