Option Trading School - Owning Stocks During a Financial Crisis

Many people are faced with the predicament of being long (owning stocks) during a financial crisis. The companies held in an investor's portfolio that were thought of as strong, stable and profitable businesses are all of a sudden volatile, risky and filled with holes.

During market volatility even the best of companies tend to sell off. A good gauge to view the overall market is to keep a close eye on SPX (the SP 500 cash index). Most stocks are going to move with the SPX so use that as your guide. Some important areas to keep an eye on right now are at 1150, 1120, 1075 and the big support area of 1050-1055 in the event we retest the lows. It is important to have a plan for all positions and not fall into two common mistakes that many people make during a financial crisis.

Paralyzed by Fear:

 

• There is a saying that the best time to plant a tree is 20 years ago but the second best time is right now. That is a perfect quote for the person going through this crisis who currently has no plan on how to protect their portfolio. As with anything in life if there is a problem you have to confront it. This does not mean that you simply sell everything, remove your cash from the bank and hide it under the mattress (after all the US debt just got downgraded and those $'s could be worthless one day).

Do not fall into the "it will come back crowd" or the "if it just gets back to my buy price I will get out". Remember that the market does not care where you got in or where you get out. Take a fresh look and analysis and ask yourself if the same reasons are present for owning the company that you had when you initially bought it. Millions of people would be much better off if they had taken the same approach of reevaluating their positions in GM, Bear Stearns, Lehman, Enron, WorldCom, etc and simply said I will take my loss here instead of waiting until the game is over.

If nothing else, analyze your position and find a place to put a stop loss order (a price where you will exit the trade if it drops further). Also, ask yourself whether or not the money would be better off if invested in something else. Remember that $100 made on AAPL and $100 made on GE both spend the same way.

There are many other things that could be done such as selling covered calls, buying puts or reducing size as ways to hedge against a decline in the stock market. Much of this information can be found via a simple Google search, but we plan on doing some step by step educational videos on these topics in our Trading and Investing 101 series due out soon.

 

The Panic Sell:

 

• At the same time that you do not want to be paralyzed from reacting to the market, you do not want to be so struck by fear that you sell in a panic. As mentioned above there are ways to reduce exposure through reducing position size, hedging or using options like covered calls or long puts. For example: if you owned 200 shares of a stock and did not feel comfortable with the market you could look at selling 1/2 of the position.

Take some time and reevaluate the current position, the companies you own and the overall market conditions before acting. This way you can make an educated decision as opposed to a rash decision. Keep in mind that despite what you think, you are not the smartest person in the world, and everything you buy does not have to go up or comeback. If you trade from more of a defensive approach with the goal to preserve risk capital you will tend to fare much better during a crisis than the cowboy that puts it all on the table and goes for home run. I know I personally have benefitted during this crisis from going through the markets in 2008 and knowing what to expect during fast moving volatile markets.

Legends are made in volatile markets like this where stories spread of a few traders who step in at the right time and take a big risk that pays off. The thing to remember is that the odds of being one of those is very low and for every one of those that paid off, there are probably 100 others that took their shot and failed. The most important thing is to make sure that you and your account are still around whenever the dust settles.

 

Danny Riley, veteran floor trader of MrTopstep said the following, "I have to say hands down I have never seen anything like this. It is one big program after another. The ESU (September ES Futures) just sold off 1144 high after the fed to down to 1098 a 46 handles drop in less than 30 mins. Also I have never seen the S&P trade so many different handles up and down." With volatility like this, the smart money is focused on protecting their risk and you should be too!

If you would like to learn about different option strategies that can be used during volatile times in the market, be sure to check out our free Option Trading School. TradingPub provides Free Online Trading Education as professional traders share from their experience, tools and techniques. Join us for one of our free online events.