“A failure is a man who has blundered, but is not able to cash in on the experience.”- Anonymous
Last week, I wrote about the ongoing crisis in the auction rate securities market. Now I'm going to share my thoughts on how to benefit from this imbroglio.
1. Once more into the breach. As the Wall Street Journal reported in their weekend edition on Saturday, the market has recovered a bit. If you have $25K, you can directly buy these debts. The morbidly obese yields of 20% are largely gone, but 8-10% remains sufficiently corpulent for my taste. This is trickier than it sounds though, I wouldn't enter any market unless I really knew it. After the Maher brothers' experience with Lehman, I'm not sure that I would trust an investment bank to help me navigate these waters either.
2. Short circuit. You could short the money center banksA(individually or through an ETF) and the bond insurers who insure auction rate bonds. As I have written previously, shorting is not for the faint of heart. It helps to have a lot of capital. As Keynes famously said, "markets can remain irrational longer than you can remain solvent." Let's not forget, shorting involves a)going against the historic market trend and b)using leverage, which requires an extra amount of discipline to use wisely. Let's not forget that we are in a rate-cutting environment. Bernanke and the Fed are handing out money like the Joker during the parade scene in Batman. These stocks seem to be rallying every other day, often on rumors.
3. Train, say your prayers, and eat your vitamins. It turns out that this is great advice not only for Hulkamaniacs, but also investors. Buy short-term treasuries. They will benefit from the rate cuts, the perception that auction rate bonds are no longer where it's at, and the generally sickening volatility in the stock market. This is boring, but effective.What about the American peso, er dollar? I know that the dollar is a flawed currency and has been desceding through Hell like Dante, but I think that there's chance for a cyclical rally this year.
4. Keeping your options open. This is for the sophisticated. You can use a number of neutral and bearish options strategies to benefit. Be warned, options make use of leverage and despite what many of its advocates say, they are not less risky. They just allow you to take on a different risk than outright equity ownership does. The price of options doesn't step for step correlate with the price of the underlying security. Volatility, time erosion, break even points, and a host of other things help establish the price at which options trade. For more information on options, contact The Options Industry Council. They have a lot of good, free information for the beginning options trader.
You can do a long straddle or strangle on the XLF. These strategies allow you to benefit from a strong price move in either direction. A long straddle involves buying a call and a put at the same price. A long strangle involves buying a call and then a put at a lower price. Both these strategies limit your risk and take advantage of volatility. Either way, time erosion will hurt your position.
If want to take an outright bearish position, you can buy puts, use a bear put spread, or a put backspread. When you buy a put, it's a simple bet that the price of the stock will decrease. The farther the stock falls from the strike price, the more the put increases in value. A bear put spread constitutes selling a put, while at the same time buying at put at a higher price. Ther is limited downside, but also limited upside. Finally, you can employ a put backspread, selling a put, while buying two other puts at lower strike prices. Again, this limits your downside, but the upside is limited, but not as much as with a bear put spread.
5. Follow the yellow brick road. This is an old favorite for those afraid of the equity market. It's like throwing to the checkdown receiver coming out of the backfield, when there's nothing downfield. This works more as a result of perception than most trades because despite the fact that there have been many periods in which gold hasn't retained value, people continue to think that it has and always will. Buy the physical metal or one of the miners if you want to take advantage of leverage. Using GLD and GDX and proxies, year to date, the metal has outperformed the miners by about a 2 to 1 margin.
6. Catch the silver bullet. SLV is up about 14% year to date. As with GLD, it has been lapping the miners so far this year. While silver doesn't have the same fetish surrounding gold, but it benefits from having industrial uses.