How to Buy Abominable Snowman Protection

This Presidents Day, I took my family to Disney’s Animal Kingdom. As my 5-year-old son and I stood in line for the Expedition Everest roller coaster, he couldn’t contain his excitement. He jumped from one foot to the other, pointing eagerly to the tracks that climbed into a (not-so-life-size) replica of Mount Everest.

But after we got on the ride, it didn’t take long for that excitement to turn to fear. Once the dark, giant shadow of a mythic Abominable Snowman appeared, my son was instantly terrified and didn’t calm down until he was on solid ground. Then, after some time, he pleaded to go on another ride — the excitement was back.

The reason I bring this story up is because it relates so well to the many investment fears running rampant today — and leads into my strategy for combatting them.

Right now, the markets are, funnily enough, acting the same way as my 5-year-old. Of course, it’s prudent to be aware of the real risks that are present. Once any of those risks comes to fruition, though (think the Abdominal Snowman), the markets panic for a while. So a pattern emerges: Markets fly high until one of the risks shows its face, then fears run rampant (think my son’s reaction) until we find solid footing. And then, after some downtime, the markets are back to flying high again, despite the risks. It’s a roller-coaster ride that keeps happening.

The S&P 500 is a prime example.

After moving practically nowhere in January, it finally broke higher and set a new record yesterday. This sent the fear indicator (aka the S&P 500 Volatility Index) plunging 17% year-to-date. The risks are still present — the Fed’s rate-hike decision, the conflict in Ukraine, Greece renegotiating its debt, American debt, ISIS, etc. Yet, the markets continue to make record highs until one of the Abominable Snowmen rears its ugly head.

When that day comes, it’s important to have a plan. And even though the main strategy in Pure Income is to sell puts, which are essentially all bullish positions, we will occasionally buy puts for security. It’s our “Abominable Snowman protection.”

So here’s the strategy…

The Protection Premise

We will sometimes buy protective puts on companies in our portfolio — an action that allows us to safeguard our gains from falling share prices and spikes of volatility. In other words, it’s an insurance play that will offset any losses.

Buying puts is the opposite of selling them, which we do when volatility is high and we’re betting on rising share prices. Today’s volatility is low, so it would be a good time to buy protection. However, I have reviewed each of our positions, and they are sitting in a nice spot at the moment. So far, we have a total of three protective puts on our long positions, and all of our short put options are profitable.

Many of the protective puts we already have in place have a specific purpose: to protect against an interest-rate rise, to reduce downside exposure, or to hedge against falling oil prices. As we go forward, I will likely use the same strategy, which will insure us against a particular risk associated with one of our trades. That way, we will be protected from any sharp downside moves.

So, as always, I will monitor the market dynamics and examine upcoming events to determine the best time for adding protection. At the moment, the biggest market concern lies with the Fed. For example, analysts were waiting for January’s FOMC minutes, which were released today. But the notes just confirmed what I said last week: The Fed is inclined to keep rates near zero for longer than many expect. After the minutes were released, stocks surged, and Omega Healthcare Investors (NYSE: OHI) rallied about 2% off the lows of the day. Another Fed event analysts will watch closely is Janet Yellen’s speech next week. But, as you know, I don’t expect the Fed to step away from its dovish narrative until autumn, the earliest. So I don’t expect anything new to be revealed in Yellen’s speech.

It’s Almost Option Expiration Time

This Friday, we have six options expiring: Coca-Cola (NYSE: KO), Coach (NYSE: COH), Select Income REIT (NYSE: SIR), People’s United Financial (Nasdaq: PBCT), and GlaxoSmithKline (NYSE: GSK).

At the end of this week, I’ll send you a dispatch that breaks down everything you can expect from those trades — from how much we collected to whether I’ll be keeping the company in mind for future recommendations.

Just look in your inbox on Friday for all the details.

And remember, if you have any questions or comments, you can always email me at pureincomeservice@gmail.com.

Regards,

Chad Shoop
Editor, Pure Income