Holding On
Vol #9 - October 2nd, 2020
Volatility is a funny thing. You can travel a long way, and end up right back where you started.
This week is a perfect example. The biggest jolt came this morning, as we got news of positive coronavirus tests by the President and his family. While not as extreme as some of the paths taken earlier this year, this morning the market is taking a tumble and set to open right about where we started the week.
This type of headline is seemingly perfectly crafted to knock investors off their kilter. It immediately stirs fear and greed; not just because of the political lightning rod, but the thirst to capture and anticipate second order effects in the markets.
Volatility is a double edged sword. Price fluctuations generate returns and compound wealth. They’re also the blade that slashes returns and stokes panic inside of us.
Without a plan, volatility will quickly separate the strong hands from the weak hands, and individual investors have an edge in beating professionals here. We’re only focused on our time horizons, the day to day doesn’t matter. Patience and long term focus are a blessing when facing off against the animal spirits of daily market fluctuations.
The daily paths of the market are completely random. Even spread out over weeks and months, there is very little predictive value. This is why long term investors extol the virtues of dollar cost averaging. By simply following a plan to put money in the market, you avoid having to make any pricing decisions. One of my favorite finance data bloggers Nick Maggiulli has a great piece about how even with perfect foresight, God himself couldn’t beat dollar cost averaging.
Volatility is a key component of options markets. It’s the main driver of how to price options. How much a stock is expected to move will determine how cheap or expensive options are. Options traders are laser focused on pricing this component properly, and quickly get into higher math models to describe it.
Here again is where individual investors can have an edge over professionals. Our strategy of “Market Neutral Returns” seeks to generate income when the market does nothing. That’s a nice simple framework to understand low volatility - from trade opening to closing, do we end up in the same place.
Professional traders are constantly trading and hedging volatility throughout the week. But while the market took a long path up, down, and around, compared to last Friday at this time, not much has changed for individuals. We don’t have to worry about how much variance happened, or what implied vol levels were realized, we just know the market is right back where it started.
You want your diversified strategies to make money when your other holdings aren’t. If you tried to hedge with variance or “pure” volatility, this week you would have lost on both counts. The market took a long path (high volatility), but ended up in the same place (0% return on equity). The professionals don’t always have the edge.
Volatility sounds scary, but when it’s well managed, it’s a blessing for individual investors. By using systematic strategies, we take advantage of long time horizons to diversify and capture returns from patience and behavioral alpha.
Thanks for joining us,
Mark Phillips
CEO
What clients are asking us:
Do you have 401(k) or IRAs?
We’re huge fans of the retirement account model, and would highly encourage readers to investigate their options there. We don’t currently have these options at Harvested, but are looking into that for the future. One interesting thing to note, is that options strategies can sit in different accounts from your 401k, and still complement your overall portfolio. Strategies like Balanced Protection and Market Neutral Returns act as great components in an overall plan.
I missed the webinar!
We missed you too! Unfortunately we had a technical malfunction that prevented recording, but we’re happy to share our slide deck with anyone who’s interested.
We’ll be scheduling a future webinar shortly though, so stay tuned!
What about social trading?
It's blog time again! We love talking about the markets at work, at home, and with our friends. But we’re careful not to confuse their objectives for our own. It’s hard to listen to tales of winners without getting a trading itch, which is why we believe in creating plans during times of calm that create behavioral alpha for investors.
Strategy Focus
This week we’ll take a look at a specific stock, and how different Harvested Financial options strategies might be used to capture opportunity. We’re working the Tradier on a weekly video series to discuss these recommendations, stay tuned on for more details.
Nikola Corp ($NKLA) has had a rough few weeks in the market. It seems hard to get worse for the electric vehicle maker with their pending General Motors deal raising eyebrows, and the founder facing his own abuse accusations. Despite this management has confirmed production targets for the next quarter.
All this uncertainty means volatility is highly elevated - October options are pricing in average daily moves of 12.5%. Even on large movement days like yesterday when the stock closed up over 17%, it’s hard to sustain that level of activity over the next two weeks.
One way to take advantage of this stock right now is by selling put spreads, or using Downside Capture. This trade has a neutral to bullish directional bias, but also captures the volatility and interest rate premium.
Selling the October 16, 2020 19/20 put spread lets you collect a small premium ($0.30) while only risking $1. If you risk $700 and NKLA doesn’t drop more than 20% over the next two weeks, you’d net $300 on this trade.
Another way to take advantage of a potential rebound in the stock would be to use a debit strategy, where you know exactly what you’re paying. Supposed you think there’s a better than 50% chance of NKLA closing up within the next few weeks as this deal comes to a close. Rolling Bull will secure trades that return two dollars for every dollar wagered on weeks when NKLA closes up.
Happy Friday
If there’s one thing we like almost as much as options strategies, it’s a good index. Indexing and the associated boom in passive investing has created simple and transparent ways for investors to access broad market returns. By investing in a broad based index via an ETF or mutual fund, investors get the average of many stocks, which beats the vast majority of active investors.
The “Dow Jones” is perhaps the most famous of all the indices. Professional investors will quibble about whether the S&P 500 or the Russell 2000 is a better benchmark, but the reality is the power of the “Dow” is compelling. Hearing how many points dropped piques interest.
The index was invented to do exactly that - gather attention. It was first calculated in 1896 by Charles Dow who was the editor of the Wall Street Journal. He wanted to sell newspapers, and having an idea of “the market” helped do exactly that.
The full name of the index we refer to as the “Dow” has the full name of “Dow Jones Industrial Average”. The list was the twelve largest industrial companies in the United States at the time. None of these companies remain in the index today. That rotation is one of the many great features that keep investors tracking today's leading companies, not yesterday's. The average has now expanded to other sectors of the economy and includes thirty companies.
The Dow is only the second oldest index in the United States. The first was also created by Charles Dow a decade earlier when he worked at Customer's Afternoon Letter, the predecessor to the Wall Street Journal.
Often we’ll see run across the news “Dow drops 200 points”. The major criticism people have with the Dow is that points aren’t representative of the change in asset prices. If the Dow was 1000, a 200 point swing means a lot more than if the Dow was 20,000. 200 is just more fun to yell than 1%.